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Stock Options 101

Welcome to Stock Options 101

Our goal is to explain stock options in simple English. As you learn more, you will appreciate how difficult a task it is. People say that investing in stock is like playing checkers, while investing in options is like playing chess. We look forward to teaching you how to play the more complex game of stock options.

Are Stock Options Risky?

Most people would answer that question with a resounding "yes". True, according to some studies, over half of all options that people buy end up being worth absolutely nothing. Nada! Tear up your ticket stub and walk away.

If buying options is such a bad investment, maybe a strategy of selling options to someone else would be a better idea. Let their loss be your gain. But there is a problem here as well - it is called selling a naked option, because that is how you feel for the whole time you have sold that option. You are facing a theoretical unlimited loss. You can lose many more times the amount you invested. At least when you bet on a horse, that is all you lose when he trips on his way to the finish line.

So if buying options is usually not a good idea, and selling them can be worse, it is easy to see why people decide that options are risky no matter what you do. It does not occur to most of them that a strategy of buying an option and simultaneously selling another option to someone else might be an entirely different story.

This website is designed to explain an options strategy that we believe is less risky than buying stock or mutual funds, and potentially a whole lot more profitable. We hope you will read through this material and learn to love the world of options as we do.

Why Trade Stock Options?

Stock options are exchanged for two main reasons: for speculation (adds risk) and for hedging (reduces risk).

Speculation

Stock options are a way of leveraging your money. This is usually done by buying call options. You are able to participate in any upward moves of a stock without having to put up all the money to buy the stock. However, if the stock does not go up in price, the call option buyer may lose 100% of his/her investment. For this reason, options are considered to be risky investments.

Hedging

Stock options can be used to considerably reduce risk. Put options are usually traded for hedging purposes. While hedging reduces risk, it also limits the amounts of gains you can make. Since most stock markets go up over time, and most people invest in stock because they hope prices will rise, there is more interest and activity in call options than there is in put options.

Terry's Tips Stock Options Trading Blog

November 22, 2021

On Target Trade


Target
(TGT) reported earnings before the bell on Wednesday that beat estimates on
both revenue and profits. The company also expects its fiscal Q4 comparable
sales growth to be higher than previous forecasts. Moreover, TGT claimed the
supply chain mess has not been an issue - store shelves are full and ready for
the holiday buying onslaught.





Analysts
were mostly bullish on the report, giving TGT several target price increases
(there was one lower price). One went as high as $350, a 38% premium to
Friday’s closing price. The stock price was not rewarded, however. The shares
dropped 4.7% on Wednesday and slid further the rest of the week. However, this
was a common theme among several retailers, including Walmart (WMT). In fact,
the overall retail sector was lower for the week.





The pullback dropped the shares to just above their 50-day moving average (blue line in chart). This trade is thus a bet that TGT will regain its footing and stay above the 50-day as holiday sales numbers – that are predicted to be robust – start rolling in. The short 245 strike (red line) of our put credit spread is below the 50-day, relying on trendline support to hold through expiration.









If
you agree that TGT will stay atop its 50-day moving average line in chart),
consider the following trade that relies on the stock remaining above 245  (through expiration in six weeks.





Buy
to Open TGT 31Dec 240 put (TGT211231P240)

Sell to Open TGT
31Dec 245 put (TGT211231P245) for a credit of $1.60 (selling a vertical)





This
credit is $0.02 less than the mid-point
of the option spread when TGT was trading around $251. Unless the stock rises
quickly from here, you should be able to get close to this amount.





Your
commission on this trade will be only $1.30 per spread.  Each spread would then yield $158.70. This
trade reduces your buying power by $500 and makes your net investment $341.30
($500 – $158.70) for one spread.  If TGT
closes above $245 on December 31, both options will expire worthless and your return on the spread would
be 46% ($158.70/$341.30).


November 15, 2021

An AFRMation Trade


Affirm
Holdings (AFRM) provides a platform for point-of-sale payments for consumers
and merchants. In August, AFRM announced a partnership with Amazon.com (AMZN)
to offer flexible payment solutions to customers with AMZN purchases above $50.
AFRM reported earnings on Wednesday after the bell that missed on profits but
beat on revenue. The company also raised sales guidance.





Wall
Street apparently forgave the earnings miss, largely because it was not clear
if the discrepancy used comparable numbers. Moreover, AFRM said its AMZN
relationship as a buy-now-pay-later service was exclusive. Clearly, analysts
were looking at AFRM’s growth prospects, as the company was greeted with
several target price upgrades that reached as high as $185 (the stock closed at
$149 on Friday).





After a nasty, four-day 21% plunge heading into earnings that pulled the stock to its 50-day moving average, the stock rebounded 13.7% the day after the earnings news. Given the earnings rebound, analyst target upgrades and deal with AMZN, we are going with a bullish trade on AFRM that keys on the stock maintaining its three-month rally and staying atop its 50-day moving average (blue line in chart). The short put strike of our credit spread sits at $133 (red line in chart), just below the 50-day.









If
you agree that AFRM will continue its uptrend and stay atop its 50-day moving
average line in chart), consider the following trade that relies on the stock
remaining above $133  (through expiration
in seven weeks.





Buy
to Open AFRM 31Dec 128 put (AFRM211231P128)

Sell to Open AFRM 31Dec
133 put (AFRM211231P133) for a credit of $1.85 (selling a vertical)





This
credit is $0.05 less than the mid-point
of the option spread when AFRM was trading at $149. Unless the stock rises
quickly from here, you should be able to get close to this amount.





Your
commission on this trade will be only $1.30 per spread.  Each spread would then yield $183.70. This
trade reduces your buying power by $500 and makes your net investment $316.30
($500 – $183.70) for one spread.  If AFRM
closes above $133 on December 31, both options will expire worthless and your return on the spread would
be 58% ($183.70/$316.30).


November 10, 2021

A Me(h)T Trade


MetLife
(MET) won’t get anyone’s juices flowing. It’s frankly a rather boring insurance
and financial services company that’s been around for 158 years. But who cares …
if we can make money on a trade, right?





MET
reported earnings last week that beat estimates on the top and bottom lines.
Hardly anyone noticed. Analysts were silent. There were no stories other than a
dry listing of its key performance numbers. And the stock fell 2% the next day.
Ho hum.





But MET is up 36% for the year, which is well ahead of the S&P 500’s 25%. After a swoon in June and July, the stock has been grinding steadily higher along the dual support of its 50-day and 200-day moving averages. The key is the 50-day (blue line in chart), which has allowed just three daily closes below it during the past three months. This trendline, which is rising slightly, sits at $61.10, which is above the short strike of our put spread trade. Thus, MET would have to pierce this support to hurt this trade. And the 200-day (red line in chart) sits at $61 to provide another layer of support. The last time MET closed below the 200-day was more than a year ago.









If
you agree that MET will continue its slow ascent and stay atop its 50-day
moving average line in chart), consider the following trade that relies on the
stock remaining above $62.50  (through
expiration in six weeks.





Buy
to Open MET 17Dec 60 put (MET211217P60)

Sell to Open MET 17Dec
62.5 put (MET211217P62.5) for a credit of $0.75 (selling a vertical)





This
credit is $0.04 less than the mid-point
of the option spread when MET was trading at $64. Unless the stock rises
quickly from here, you should be able to get close to this amount.





Your
commission on this trade will be only $1.30 per spread.  Each spread would then yield $73.70. This
trade reduces your buying power by $250 and makes your net investment $176.30
($250 – $73.70) for one spread.  If MET
closes above $62.50 on December 17, both options will expire worthless and your return on the spread would
be 42% ($73.70/$176.30).


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