Four Critical Steps for Options Trading

close-up photo of monitor displaying graph

Simple Option Trading Strategy – How to Get Quick, Low Risk Profits

Options Trading allows investors to take a small investment – perhaps of $1000 or less – and quickly earn 2, 3, or 4 times the amount invested without risking anything more than the initial investment. Often one only risks a small part of the initial investment. Four key steps go into a highly profitable options trade. Ignore or make a mistake on any one of these steps and the stock or commodities option trade will be a loser. Follow these steps carefully, and the odds stack heavily in favor of earning the gold at the end of the option rainbow.

Strategies for Profitable Options Trading

1. Pick an Options Market primed for a big turn.

For example, in August of ’09 the silver market was primed for a rapid climb in value within a short period. August also saw the sugar market set up for a big fall in value within a few weeks. A future article on spotting the trend change will help uncover these markets poised for the big turn or trend change.

Up or down does not matter. Trading options successfully requires big moves in either direction. Going long or buying calls, means that a price rise will bring profit. Going short or buying puts, means a price fall will be a profitable options strategy. Stock trading or commodity trading have different characteristics but the principles of hunting for a big potential move are the same.

2. Only buy heavily traded options.

Liquidity for any market means being able to sell stock, Stock Options, futures contracts, or commodity options contracts quickly without having to wait for a willing buyer. Without many buyers involved in the selected options market, buying and selling the same contract, there is not enough liquidity for getting out of the option – and getting to cash – when it comes time to close out the position.

Before committing to an option purchase, look at the volume for the day, and the OI or Open Interest. If these are a low number or 0- as they often are, avoid buying the option!

3. Get far out in an options trade.

Buy a contract at least 90 days out. This step minimizes time decay in the option value. If the silver market mentioned in #1 looks setup for a big move that might happen in September, buy the latest high volume option available. In this case, the Jan 10 appears as a high volume option, subject to the correct strike price. After Jan 10, the volume per option drops enough that the liquidity becomes low for the options trade and a trader could get stuck being unable to cash out. Cashing out is where the profit is.

4. Pick a far off strike price with low cost options.

An options strike price refers to the price where the options’ purchaser has the right but not the obligation to buy the underlying stock or commodity. Even if the underlying stock or commodity never gets to the strike price, as it gets closer within a reasonable period of time, the option can become much more valuable.

Real Trade with Commodity Options Profit

Going back to silver option example, in August ’09 one could buy an SLV (the silver exchange traded fund -ETF) option at a $20 strike by Jan ’10 for $25 per option. SLV was quoted at $13.52, a difference of almost $6.50 to the option strike price. When silver quickly moved up to $17.20 in September, the option price jumped to $75 in less than three weeks!

Trading options with these strategies offers the key to making profits in either stock or commodity options.