Sean Hyman - Option Trading Demystified: Six Simple Trading Strategies That Will Give You an Edge

Im a stock guy. I love the stock market. Its a great way to invest your capital into large, well-capitalized companies and make great money over time. So I focus a lot of my portfolio on this kind of stock investing.

But I always get a lot of questions from people about options on stocks, aka options trading. People love the thought of options because they require less money up front and they can have even higher returns than a stock itself.

However, Ive learned that most people dont do all that well trading options because they do it all wrong.

You see, with stock investing, all you have to do is determine the direction of a stock. And if you feel the stock is going to go up, you buy and hold onto it until it appreciates in value.

So with stocks all you have to determine is the direction of the stock (up or down). However, options are a whole different animal.

With them, you have to determine the direction, and that direction has to happen well before the options contract expires. But youve also got to take into account the volatility factor of a stock too.

(It is for these reasons that some traders get the direction of the stock right and still lose money on their option. Dont worry! By simply following the strategies that Im giving you today, youll automatically be putting yourself on the correct side of the volatility and direction game.)

People can make options complicated if they try hard enough. After all, there are a lot of fancy ways to measure all kinds of metrics concerning an option: deltas, gammas, thetas, etc. It sounds like a bunch of fraternities on a college campus.

However, in this guide, I wont get into those types of things which are more complicated. Instead, Im going to show you much easier tips that you can use which will greatly increase your odds when it comes to your options trading.

Again, have the bulk of your assets in solid stocks that you are invested in over long periods of time. Only take a small percentage of your investable net worth and put it into options.

Also know that options contain a higher degree of risk than buying a stock outright. After all, if you ever needed or wanted to, you could hold a stock for 50 years while you allowed for that stock to become profitable. But with options, there is a limited time frame (typically one to two years or less).

But if you use the tips that Im going to give you today, youll stand a great chance of increasing your option returns.

Ok, so lets get started.

Technically, an option contract is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date in time.

Now, let me simplify that with a similar analogy.

Most of you are familiar with how a home purchase works. You find a house you like. You want to buy it, but you dont have all of the cash for the house. Lets say that house costs $200,000. Since you dont have $200,000 in your bank account in cash, you turn to a bank for financing.

What do they do? They will tell you to put up a down payment on the house. Lets say they require you to put down 10% (which would be $20,000).

What happened? The bank essentially gave you the right to control the $200,000 house with only $20,000 down out of your own pocket. If that house appreciates from $200,000 up to $220,000 who gets to keep the $20,000 in appreciation? You do. So even though you didnt pay for the entire house yet, you still get to benefit from the homes gain.

Therefore, if you sold that home (not counting realtors fees, etc.), youd make a 100% gain on your money because you used $20,000 down to gain $20,000 in appreciation of the price of the house. Had you owned the entire house outright, your gain would have only been a 10% gain instead of a 100% gain.

And its a similar thing with stock options. With a little bit of money, you get to control some shares of stock for a period of time. If the stock goes up enough during the time in which you own it, youll make a profit on the options contract and it could end up being a very sizable profit, much more than what you could make off of owning the stock outright (just like in the house scenario above).

The good thing about an option is that you can place a trade on whether the stock price will go upward OR downward. In other words, if you think a stock is going to have a huge dip, you can take advantage of that and profit from it as well through options.

When you want to benefit from a stock going up, you buy a call. But when you want to benefit from a stock going down, you buy a put.

There are other types of options strategies out there. But this guide will focus on the most common strategies which are based upon a stocks direction. In other words, you gain money in your options trade if the stock either goes up like you thought it would or if it goes down like you thought it would (depending on whether you bought a call or a put).

This guide will focus on option tips for when you expect a stock to rise in price (using calls). You see, the thing about options trading is that all you have to know is one strategy and you can make money. You dont have to know every complex type of strategy out there.

Sometimes people muddy the waters by trying to figure out every possible strategy out there.

You see, even with a strategy that looks for a stock going upward, the stock doesnt necessarily have to be trending higher overall. It just has to head higher overall for the period of time in which you own the option.

Later, Ill dig into more detail along these lines, but I figured Id plant that seed in your mind early on so you wouldnt worry about only being able to use these tips part of the time when markets were moving upward.

This while this guide wont go terribly deep into every possible option and strategy, you can dig deeper into understanding options through websites like:

www.cboe.com

Thats an options exchange that has a great educational section on their site. Simply click on the Education tab at the top of their page to get information on webcasts, online courses and seminars, etc. Its a great resource to dig deeper into the topic of options. But for the purpose of this guide, Im going to teach you some of the basics of an option and then go into the options trading tips.

Investopedia.com is another great website for investing and trading education. If you want to know about a certain investing term or strategy, simply put in the word you want to know more about into its search box and click on the search button and youll find short and concise articles about the topic at hand.

Additionally, most stock brokerage firms that youd hold your account with will also hold options classes in their branches or online on their website. So your brokers website can be a great resource for options information too.

Some examples of brokerage firms that you can check into are:

www.ameritrade.com

www.optionsexpress.com

www.tradeking.com

www.schwab.com

www.scottrade.com

www.etrade.com

www.fidelity.com

There are three main advantages to options: 1) Control, 2) Leverage and 3) Protection

Just as you can control a $200,000 house with a $20,000 down payment, you can control shares of a stock via an options contract. (One option contract controls 100 shares of stock).