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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

December 5, 2022

December 5, 2022

Ulta Beauty (ULTA) reported impressive earnings on Thursday after the bell that beat estimates on all counts. Earnings came in more than a dollar higher than expectations, while revenue beat by more than 4%. Same-store sales came in a whopping 60% above the analyst number. Moreover, ULTA raised full-year guidance for both earnings and sales. Significantly, the common complaints of supply chain constraints and slower consumer spending were absent from ULTA’s report and follow-up call.

Analysts cheered the news, hitting the stock with several target price increases, though there were no rating upgrades. Even so, the consensus price target is just a mere 4% above ULTA’s Friday close, while more than half the covering analysts rate the stock a hold. This suggests that future upgrades and target increases are possible, which could give the stock a boost.

Despite the solid report, ULTA was flat on Friday. Perhaps this is because the stock is on an impressive 26% rally since late October. In fact, ULTA hit an all-time high on Friday. This rally has been tracked by the 20-day moving average, although the trendline has not been tested for the past month. We are going with a safer trade this week, going further out of the money than usual with the short strike that is sitting right on the 20-day, as shown in the chart.

This trade is based on ULTA continuing its rally on the heels of a strong earnings report. That said, we are giving the stock about 7% of downside room before the spread moves into the money. If you agree that ULTA will continue its rally – or at least remain atop the 20-day (blue line) – consider the following trade that relies on the stock staying above $440 (red line) through expiration in seven weeks:

Buy to Open the ULTA 20 Jan 435 put (ULTA230120P435)
Sell to Open the ULTA 20 Jan 440 put (ULTA230120P440) for a credit of $1.00 (selling a vertical)

This credit is $0.05 less than the mid-point price of the spread at Friday’s $471.33 close. Unless ULTA surges quickly, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $98.70. This trade reduces your buying power by $500, making your net investment $401.30 per spread ($500 – $98.70). If ULTA closes above $440 on Jan. 20, both options will expire worthless and your return on the spread would be 25% ($98.70/$401.30). 

November 28, 2022

November 28, 2022

Medical-device maker Medtronic (MDT) reported earnings this week that hardly impressed the Street. Quarterly sales and earnings fell from a year earlier, with revenue falling short of analyst expectations while profits met projections. The company also cut its full-year guidance, citing the usual supply-chain disruptions and a slower recovery in medical procedures postponed due to the pandemic.

MDT’s report was met with a couple of downgrades along with a heavy dose of target price declines. Nevertheless, the average price target sits above $94, about 19% higher than Friday’s close. That leaves room for more price target cutbacks.

The stock price has been sliding from more than a year, falling 42% from a record high reached in Sep. 2021. Since April, MDT has displayed a pattern of lower highs and lows with the 50-day moving average keeping a lid on brief rallies. The 50-day currently sits at $83, which is also the strike of the short call in our credit spread. This trade is thus based on the current downtrend continuing, with the declining 50-day providing resistance and keeping our spread out of the money.

If you agree that MDT will continue to trade beneath the 50-day moving average (blue line), consider the following trade that relies on the stock staying below $83 (red line) through expiration in six weeks:

Buy to Open the MDT 6 Jan 85 call (MDT230106C85)
Sell to Open the MDT 6 Jan 83 call (MDT230106C83) for a credit of $0.40 (selling a vertical)

This credit is $0.03 less than the mid-point price of the spread at Friday’s $79.12 close. Unless MDT falls quickly, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $38.70. This trade reduces your buying power by $200, making your net investment $161.30 per spread ($200 – $38.70). If MDT closes below $83 on Jan. 6, both options will expire worthless and your return on the spread would be 24% ($38.70/$161.30). 

November 21, 2022

November 21, 2022

Down Goes Tyson

Tyson Foods (TSN) can’t seem to get out of its own way. The company reported earnings on Nov. 14 that missed estimates on profits but beat on revenue. Higher chicken prices squeezed gross margins, which were cut in half.

But TSN has other problems. The week before earnings, the company’s CFO was arrested for public intoxication and criminal trespass. This week, the company recalled 94,000 pounds of ground beef that reportedly contained a “reflective, mirror-like material,” whatever that means.

Analysts didn’t seem to like the earnings news, as the stock was hit with a few target price downgrades. Even so, the average price target is 24% above Friday’s close, which seems overly optimistic. Perhaps the options market is more in touch with TSN’s prospects, as out-of-the-money puts are priced higher than the corresponding calls.

The stock traded lower after earnings and throughout the week, falling nearly 3%. While hardly catastrophic, the more bearish development is the continued resistance provided by the 50-day moving average. The stock hasn’t closed a day above the 50-day since it crossed below it in early August. Moreover, recent rally attempts in the past couple of weeks were firmly rebuffed.

This trade is based on TSN continuing to trade sideways or lower beneath the weight of the 50-day moving average (blue line). Note that the short call strike (red line) of our credit spread lies just above this trendline, meaning that TSN will have to overcome this resistance to put our spread in danger

If you agree that TSN will continue to trade beneath the 50-day moving average, consider the following trade that relies on the stock staying below $67.50 through expiration in four weeks:

Buy to Open the TSN 16 Dec 70 call (TSN221216C70)
Sell to Open the TSN 16 Dec 67.5 call (TSN221216C67.5) for a credit of $0.50 (selling a vertical)

This credit is $0.02 less than the mid-point price of the spread at Friday’s $65.52 close. Unless TSN falls quickly, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $48.70. This trade reduces your buying power by $250, making your net investment $201.30 per spread ($250 – $48.70). If TSN closes below $67.50 on Dec. 16, both options will expire worthless and your return on the spread would be 24% ($48.70/$201.30). 

Upcoming Market Dates:

Thursday, November 24th. Market closed for Thanksgiving
Friday, November 25th. Market closes early at 1:00 p.m. ET

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    Options are not suitable for all investors as the special risks inherent to options trading my expose investors to potentially rapid and substantial losses. Please read Characteristics and Risks of Standardized Options before investing in options

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