5 Options Trading Strategies for Beginners [Higher Return, Lower Risk]

options trading can seem like gambling with the potential to make loads of money magically appear or disappear in an instant but understanding how to trade options can help you both lower your risk and make more money in your investments in this video i'm giving you a complete guide on options investing everything you need to make money with these investments then i'll reveal five options trading strategies that every investor must know we're talking trading options today on let's talk money make money make your money work creating the financial future you deserve talk money hey bowtie nation joseph hogue with the let's talk money channel here on youtube i want to send a special shout out to all you out there in the nation thank you for spending a part of your day to be here if you're not part of that community yet just click that little red subscribe button it's free and you'll never miss an episode and nation today is one of our most requested videos a complete guide on options investing and trading strategies there is no other investment that's going to help you lower your risk and make more money like options and i'm excited to put this one together in my own portfolio i've used options to profit from the news making over five thousand dollars in a single day on shares of boeing i've also used call options to lower my risk in shares of teva pocketing over 6 000 on my position and even made money when the market tanked in september making over eighteen thousand dollars with put options on the s p 500 every investor needs options investing in their toolbox now this is going to be a ginormous video and all-in-one options for beginners from start to finish so so be sure to save it for reference later i'll include timestamps in the video description below so you can jump around to specific parts if you like it's part of a special investing education series that i'm starting showing you what it really means to analyze stocks and invest your money i'll be using content straight out of the curriculum for the chartered financial analyst designation the cfa the gold standard for stock analysts working on wall street i'm going to be putting this one and all those videos into a playlist called how to invest in stocks right here on the channel make sure you tap that subscribe button so you don't miss any of these because i got some great in-depth videos coming like how to read a company's financial statements to technical analysis and how to beat those investor behaviors that lose your money in this video i'll start with the basics like what are options and terms you need to know like the expiration date strike price and contracts i'll show you how options can lower your risk increase your returns or both and how to make money using them then i'll explain step by step those five options trading strategies covered calls protective puts spreads straddles and collars and exactly when to use each so options are special types of investments called derivatives because they derive their price from another investment we'll be talking about stock options here so these are investments where the price follows a stock price now options give you the right to buy or sell a stock for a specified price on a specified date for example buying a call option gives you the right to buy shares of a stock while put options give you the right to sell that stock now let's look at an example because it's really not as complicated as it sounds here we see the options for shares of apple trading at 119 dollars per share right now across the top here you see these are the options for different dates from november 13th all the way through january 2023 these are called the expiration dates so how long each set of options lasts most stocks have options that expire each month and then longer dated ones that expire in january of each year some of the more popular stocks and funds even have options that expire every week so these options with an expiration date of january 15 2021 give me the right to buy or sell shares of apple on that date about two months from now and the price at which i can buy or sell those shares is called the strike price this is seen here in the middle of the table each of these rows is a different option for the shares at that price for example in the middle here is 120 the options here are going to give me the right to buy or sell shares of apple for a hundred and twenty dollars each in january that's no matter where the shares are at at that point if apple is trading at 150 dollars per share in january i can still buy it at 120 each if i have this option investment so you can already see how this can be a powerful investment options are going to allow me to buy a stock for less than the market price sometime in the future or even we could sell it for more than the market price now of course you don't just get that ability to lock in a stock price for nothing to buy an option you pay what's called a premium now here on each side of the stock price we see the bid and the ask columns and then the last price at which the option was traded the bid is just how much someone is willing to pay for that option and the ask is how much someone is willing to sell it for right now in the market but we'll get to that a little bit later if we look at this hundred and twenty dollar strike price again that last price of six dollars and 30 cents on the left is the price that you would pay per share to be able to buy those shares of apple for a hundred and twenty dollars in january no matter where it's trading at on that date now there are two types of options here call options and put options and you see them on each side of the table call options give you the right to buy shares at that price in the future and for each of these there's a buyer and a seller of course one investor buys a call for the right to buy shares of apple at 120 dollars per share they pay that six dollars and 30 cents per share on the right here another investor that's going to sell that call option they give the other investor the right to buy those shares from them at that price and in return they're going to collect that six dollar and thirty cents per share of that premium for example let's say you did buy these call options on apple at that hundred and twenty dollar strike price now each option contract is for a hundred shares so if you buy two contracts you would actually be getting the right to buy two hundred shares of apple if you paid that last price of six dollars and thirty cents per share that means you paid twelve hundred and sixty dollars that's six dollars and thirty cents times two hundred shares you pay that right now to buy the call option so if shares of apple rise to a hundred and fifty dollars each by january you can buy those shares for 120 each because you have that option you have that call option so you could actually pay twenty four thousand dollars that's 120 dollars each for those 200 shares for the shares that are worth immediately thirty thousand dollars that's two hundred shares at 150 dollars in the market now most options traders they don't actually put up the money to buy or sell those shares when the options expire since those options would be worth about six thousand dollars as they get closer to expiration that's because whoever owns the options can immediately turn them around for that profit then the options trader is just going to sell the option before they expire they're going to book that profit before even having to buy the shares of apple anyway i know this is a lot of information but we're going to go over a lot of examples throughout the video so it's all going to become clear as we go especially when we get into those options trading strategies now put options on the other hand give you the right to sell shares at that price in the future if you thought shares of apple were going to fall then you could go and buy these put options at the 120 strike price and be able to sell apple at that price come january now you'd pay six dollars and 43 cents per share here this premium for that right to sell the shares of apple at 120 each so if you bought those two contracts of the put options so if you paid the 1286 that's 200 for 202 contracts 200 times that 6.43 each share premium right now to buy the put option if shares of apple fell to say a hundred dollars each by january you could then sell them for the 120 each because you have that put option you have that option so you collect the difference of twenty dollars for each of those shares immediately each of those two hundred shares for a four thousand dollar profit and that's just two uses of options trading though profiting off the rise and fall in a stock price there are a lot more uses though including synthetic positions so being able to invest in a stock for a lot less for example to buy a hundred shares of apple you'd have to put up almost twelve thousand dollars at the current price but with options you can invest just six dollars and 30 cents per share in our example you pay 630 dollars for that same 100 shares of apple and get the same investment exposure to the stock and other uses for options trading include lowering your downside risk in a stock investing ahead of certain news events and just profiting as the volatility in a stock price moves higher or lower there are just a lot of great strategies for using these low cost investments to do everything from lower your risk to to making outsized returns options trading and strategies definitely need to be in your toolbox i want to go over a few more of those options trading basics and then we'll cover some examples and those five trading strategies let's switch it up here a little bit and look at options for shares of tesla now you see again we can buy weekly options here in november and december there's options expiring here in different months next year as well as out to 2022 and then as late as january 2023 so you can buy the right to buy or sell shares of tesla for a specific price all the way out to two years now one thing you'll notice here is the prices for these options change for the different months and the years for example you can buy these january 2021 call options for tesla at the strike price of 420 dollars per share for about 44 each you lock in that price for tesla by paying that 44 premium and you're going to be able to pay just 420 for the shares on january 15th no matter how much they are in the market now if we look at the january 2023 options though you see that same strike price of 420 per share that would cost you 160 each to lock in that price for shares of tesla out more than two years in the future obviously you're going to have to pay more for this because this call option gives you that right to buy shares at that 420 price for a much longer time in options trading we say this has more time value now you'll also notice within each of these expiration dates so each of these weeks and months of the options the price changes for different strike prices up and down the table for example if you want to lock in the price of 405 dollars per share of tesla up to january 2021 you'd have to pay about 50 dollars per share to buy those call options but if you want to lock in the price at 435 dollars per share you'd only have to pay 37.15 for each call option there the difference in the price here is because of where the market price of tesla is right now obviously if you were able to lock in tesla at 405 dollars per share with it already at 422 dollars a share in the market that's a great deal and it could get even better if the stock keeps moving higher so any investor that's going to sell you those call options they're going to want to make more money on that deal now on the other hand those call options for the right to buy tesla at 435.00 each those are above the current market price there's some risk that the share price won't even make it up to 435 by january which which would make those options investment worthless so any investor buying these options isn't going to pay as much so so you get that 37 premium now that brings up an important point about options trading you know whereas if you buy a stock you're going to keep that investment no matter where the share price goes if you buy shares of tesla here at 422 each you're going to keep that stock whether it goes to 500 each or or if it falls to 400 per share options are different though if you have that call option on tesla let's say you buy the call option to buy the shares at 420 on the january expiration if the share price of tesla falls to 400 by then well you're not going to use that option to buy shares for 420 if you could just go to the market and buy them for 400 each basically that option that you bought is now worthless you paid forty three hundred and eighty five dollars that's that premium of forty three dollars and eighty five cents each times the 100 call options but shares of tesla fell below your strike price so in this scenario you're just going to let those options expire the person that sold them to you is going to keep that premium keep the money that you paid and nothing else is going to happen so there is some risks in options trading even though some of the strategies that we'll look at will help you actually lower your overall risk there is the risk in just buying these calls or the put options that the share price is going to move against you and you'll lose the premium that you paid on those options now as i hinted at earlier you don't have to wait until expiration date to sell your options if you buy these january options for tesla the price the other investors are paying for that same option is going to change as the stock price changes so if shares of tesla increased to 450 each then that call option to buy it 420 is going to be more valuable so that price is going to increase as well instead of the 44 dollars per share that you paid for that call option maybe it increases to 55 each and you'd be able to sell your option for that price making a quick profit without even having to hold them to that january expiration now another thing you'll notice though the blue areas on the table for call options strike prices below the current market price those options are said to be in the money or itm now they give you the right to buy shares of tesla here at those strike prices that are below the current market price by contrast the call options above the current market price are said to be out of the money or otm these are the strike prices or the words higher than the current market price of the stock and it's just the opposite here on the right for the put options remember put options give you the right to sell the shares so they become more profitable as the share price falls the put options with the strike prices below the current market price those are out of the money while those that allow you to sell the shares for more than they're worth in the market right now those are in the money now deciding on which strike price and which options expiration date is going to be a big part of the strategies that we're going to talk about for example you can get a cheaper call option if you buy a near dated one that's out of the money so maybe buying the tesla call option for january 2021 at the 435 dollar strike price those are only 37 each because shares of tesla have to rise quickly in just two months really for you to make any money on the other hand those call options to buy tesla at 400 each right now through january 2023 those would cost quite a bit more now in each of the options trading strategies i'll show you how to decide which strike price and which options expiration you should buy that's pretty much the basics of investing in options though now we'll go into a little bit more detail on those call options and the put options when to invest in each and how to make money before we get to those five trading strategies first though i want to throw this out to the community what do you want to use options for and what strategy do you think works best for you whether it's lowering your risk or leveraging your investment to make more money so scroll down and tell us in the comments below why are you using options trading so again a call option is just the right to buy shares of a stock at a certain price by a certain date now some reasons you might use call options include taking a position in a stock for less money for example being able to invest in shares of tesla for fifty dollars a share instead of that four hundred twenty dollars each in the market now you can also collect money on your investment so selling call options to collect the premium is really a way to create that cash flow on non-dividend paying stocks you can also lower your risk in a stock by collecting that money from selling those calls something called a covered call strategy and we'll talk about that in our trading strategies next pros of call options are that they cost less money for each share and you get that leveraged return if shares of tesla rise by twenty dollars each that's less than a five percent gain on the current price of four hundred twenty two dollars a share but if you paid that fifty dollars each for each call option and the share price rise is about twenty dollars then you could be looking at a forty percent return on that options trade call options also allow you to collect some money on shares you own and lower your risk in the investment the downside to call options though is the premium you pay to buy that option can be pretty high here we're looking at call options for a 420 strike price costing 44 each so it costs you 40 bucks just to buy the option where the stock is trading right now if the price of tesla shares fall below that 420 strike price then that option expires worthless and you're out of the money now another downside for call options and some of the trading strategies we'll look at is that call options can limit your upside return if you sell them even as they lower your risk put options here remember these are the right to sell shares of a stock at a certain price by a certain date and some reasons you might want to use put options include being able to short a stock without margin so benefiting from a drop in the stock price you can also lock in those gains or limit losses on a specific stock or even against an entire market crash for example if i own shares of tesla but i'm afraid of a stock market crash might wipe out the stock i can buy put options for the right to sell the shares at a certain price if i buy that 410 dollar strike price i pay this 36 dollars per share but that gives me the right to sell the shares at that price at 410 dollars each no matter where they're at in the market on this expiration date of january 2021 if the shares crashed to 350 each doesn't matter i can sell mine at 410 each because i've got this put option if shares keep rising i keep profiting from the increase in my shares and i'll just let that put option expire without selling now another use for put options and this is a great one that most investors don't think about is getting shares of stock for a lower price for a discount this strategy is called the cash secured put and it's really interesting it's a really interesting way to profit on shares of a stock or just to pick up those shares of an investment for less so for example if i wanted to buy shares of tesla in the market right now 100 shares are going to cost me over 42 000 at the current market price but i can sell the put options so i'll sell one contract of the january put option here each contract is worth that 100 shares and i can collect the 42.70 each share when i sell these options to another investor now remember buying a put option is going to give you the right to sell those shares while selling that put option which is what i'm doing now means you have to buy them at that price so if i sell the january put options at a 420 strike price on tesla i'm committing to buy those shares from another investor whoever is buying those put options from me for that price and then let's look at the two possible outcomes here so that investor buying the put options is gonna pay me forty two dollars and seventy cents each or about four thousand two hundred and seventy dollars for those hundred shares now i'm gonna keep that money no matter what if shares of tesla stay above 420 each by expiration on january 15th the option buyer isn't going to do anything they wouldn't sell these shares of 420 each to me with that put option if they could just sell them more in the market if shares are priced at 450 each in january they wouldn't use that put option to sell them to me for 420 so so they would just go and sell their shares in the for in the market for 450 i would keep that 4 270 dollars from just selling the put options contract and i don't have to do anything i've made over four grand for not doing anything now if on the other hand shares of tesla do fall so we'll say 410 dollars each by january i've committed to buying them for 420 from that investor that bought the put option i still keep that premium that 42 dollars for each share that they paid for the print put option but now i have to buy this investors shares for 420 each share but the really cool part of this is if i wanted to buy those shares of tesla anyway then i would have had to pay that 422 dollars each in november this way i lower my cost in the shares by that 42 dollars and 70 cents each buy that premium i bought the shares for 420 each from the investor with that put option but i really only paid like 377 dollars each because i had already collected the 42 dollar premium when i sold the put options so this cash secured put strategy is just a way to either collect that money for selling the puts and doing nothing or you get the shares for a price less than you would have paid in the market anyway it's a great way to get a discount on all your investments so really you can make money trading options in a number of ways and buying calls you make money when the share price increases buying puts you make money if the share price falls you can lower your risk in a stock by selling call options or or buying puts you can even mix and match your options to profit whether a stock price rises or falls now to show you how to do that let's look at these five options trading strategies i'm going to detail each strategy exactly when you would want to use these and then how to set it up then i'm going to share an easy table that's going to put all this together and make it as simple as possible our first option trading strategy is the covered call and i'd say this accounts for the majority of my options trading now a covered call is where you own the shares of a stock and then sell call options against them in our tesla example if i owned 100 shares of tesla i could then sell a call option maybe at a 435 dollar strike price and collect that 37.45 per share and then two things could happen if shares of tesla don't increase to that 435 dollars each by january or above that amount then i keep my shares and that 37 premium for the call option the investor that bought the call options off me isn't going to buy the shares for that 435 dollar strike price if they can just go into the market and buy the shares for less so i keep my shares and about thirty seven hundred dollars for each call contract the other scenario on the other hand is if shares of tesla do rise to over the 435 dollars each by january then the investor is going to buy my shares off me at that price they're going to use the call option that they bought i keep that 37.45 each the premium and then i sell my shares for the 435 dollar strike price now getting less for your shares than the market price sounds like a deal but but there are some very good reasons why you would want to use this covered call strategy collecting that 37.45 per share premium means you lower your risk in the shares if you're worried about maybe some near-term weakness in tesla then it's a great way to make some money on the position even if the share price falls even if the share price rises though and you sell your shares for 435 dollars in this example the fact that you collected that premium means the price you actually got for your shares is much higher you're actually getting 435 dollars plus that 37.45 for each share or a total of 472 dollars each since these prices are for the january calls that's a 12 return in just two months from that 422 share price where the stock is at right now 12 in two months pretty damn good another reason why you might use this covered call strategy is just a cash flow on a non-dividend paying stock dividend investors aren't going to be getting anything on shares of tesla for quite a while but i can go into these january 2022 options so about a year out from now i can sell the 470 strike price call options and collect ninety seven dollars each that ninety seven dollars on each share here is about a twenty three percent cash return a twenty three percent dividend and as long as the share price stays under the 470 dollar strike price when the options expire next year in january 2022 then i keep the shares and can sell another call option for more cash flow now this is a strategy i've used on both cisco and tivo recently i like cisco as a long-term play on that cloud computing and the other trends but was worried about that near-term outlook i bought shares at 39.50 each and at the same time sold a call option at a strike price of 45 dollars for about 365 each so you can see even though my shares are down 51 cents each so far the value of that call that i sold is down to three dollars and 37 cents so i've actually made two dollars and 86 cents per share or about a seven percent return on the investment as long as the cisco shares stay under 45 each over the next two months to that january 15th expiration i'll keep the entire premium that 364 dollars and my shares and it's the same thing with kiva here i bought the shares at 9.58 each and think they can go a lot higher after all this opioid litigation gets cleared up but i didn't think the stock was going to zoom higher in the near term so i sold 10 call option contracts that's a thousand shares for a 10 strike price collected that dollar eight each then i sold another 40 contracts for about four thousand shares at a thirteen dollar strike for a dollar sixty three premium so now what happened here i paid forty seven thousand nine hundred dollars for that five thousand shares of tiva and you can see i'm up about 418 dollars as the share price has gone up a little bit so i also collected that thousand and eighty dollars by selling the ten dollar call options on the thousand shares now if the share price stays under ten dollars over the next two months i'll keep that money and the shares if the share price though goes over ten dollars i'll still keep the money but i'll get ten dollars each for that thousand shares for a total of about fifteen point six percent return that's the ten dollars per share plus the dollar and eight divided by the price that i paid i also collected sixty five hundred dollars by selling the thirteen dollar call options on those four thousand shares so here if the price stays under thirteen dollars over the next two months and it looks like it probably will then i'll keep that money and the shares i'll have made a 17 return and can sell more call options or if i just want to hold on to the shares and let those run now you'll notice though in both of these call options that the market price of these options has gone down and i've made a profit already investors are paying just 16 cents a share for those 13 strike price call options so so i could actually go back into the market buy back those options that i sold for that price and then keep almost six thousand dollars that i've already made i keep that money and wouldn't have to worry about my shares being called away if they jump over the strike price you'll see these profit and loss diagrams a lot with these options trading strategies but i wanted to go through the basics before because they can be a little confusing at first glance now the diagram here shows this covered call example of buying a stock at 15.84 and selling the 17 strike calls for a dollar 44 each so you've bought the stock and you're selling another investor the call the option to buy that stock from you at 17 each and you're collecting that dollar 44 premium for the each call now the maximum gain on this stock is 2 dollars and 60 cents per share that's if the stock price goes to 17 each or higher and you have to sell it for that price to the call option buyer so in this scenario you make the difference between 17 and the price you paid that 15.84 cents per share and you also keep that dollar 44 premium for the call so a total profit of two dollars and sixty cents per share your break even point on the shares though is lower than that price you paid because because you keep that call premium in any case you paid that fifteen dollars and eighty four cents per share but then minus the dollar forty four cents per share that means your cost is really only fourteen dollars and forty cents each the shares could fall nine percent and you'd still be making money on this investment your maximum potential loss in this example is still going to be that fourteen dollars and forty cents per share the covered call strategy doesn't totally limit your potential loss here like we'll see what the protective put strategy next this strategy is just going to lower your risk so if the shares fall below that 14 and 40 cents per share you're still going to be losing money the great thing about that covered call strategy though is that even if the share price falls the stock price falls you're going to keep that money collected on the options and you keep the stock that means you can sell more options against it in the future collecting more money or just wait for the stock price to rebound again the reasons you'd use a covered call strategy include reducing your risk on an investment or if you're worried about near-term weakness on that long-term stock pick it also allows you to collect cash on an investment whether it pays a dividend or not the downside of course is that it limits your potential return if the share prices zoom higher you've sold someone the right to buy those shares for a certain price and that's the price you lock in even if the stock price jumps higher now we've already seen how i use this strategy on shares of cisco and tiva but i want to show you how to set it up in real time so say i want to buy shares of tesla but i don't think the share price is going to do much over the next couple of months i can go into the options tab here to see the different months available and i'll use these january 2021 options but you can see you've got a lot of different expirations here now there are going to be lots of strike prices available maybe i think the price can go as high as 440 or so by january i wanna reduce my downside just in case so i go to the four hundred forty dollar strike price call options and i see the last price here was thirty two dollars each now some stock platforms are going to have a covered call order screen or you might just click something like add a stock leg here that's going to give you the option to buy the stock and sell the call options at the same time now if i do that i can buy a hundred shares of tesla for around 413.86 here and so one contract call option that's 100 shares expiring january 15 2021 at a 440 strike price now you see here for that call option there's an investor willing to pay 31.95 and another investor asking 32 dollars and 25 cents to sell those options that's the bid ask spread that 30 cent spread isn't really very much here on some options it's going to be much larger i always try to do a net debit limit order when i'm doing these covered calls this means you're going to put in the exact price that you want to pay for this position the price you're paying for the shares and the money you collect by selling those call options so at that price of 413.86 for the shares and the spread and the bid ask price this position is either going to cost me a net debit of 381.53 or 381.95 or somewhere in between there now that's to buy a hundred shares of tesla and simultaneously sell the call options against it now that's really not a bad spread really nothing 30 cents so i'll just put in my order at the mid point here so i make sure that i get this traded it would cost me 38 175 dollars for this entire trade so if shares of tesla stay under that 440 dollar strike price by january expiration i'm going to keep the cash collected and basically get the shares for an eight percent discount by selling those calls now even if they move above that price though i still make a 13 return in just two months so so not too bad either way the protective put strategy is a way of completely limiting your risk on a stock by setting a bottom price for your shares in this strategy you buy puts against a stock you own giving you the right to sell the shares at a certain price even if they fall for example if i own those shares of tesla but i'm worried about the stock crashing and want to reduce my risk even further beyond that covered call strategy i can go in here and buy put options for the 405 dollar strike price for just over 36 dollars a share this would give me the right to sell those shares at 405 dollars each no matter how far they drop by that january expiration now you can also use this strategy to protect your entire portfolio of stocks with puts on that overall market for example if i was worried about the market but didn't want to risk losing any of my long-term stocks with an option strategy i could go into the options for the spyder s p 500 etf that's ticker spy which is a fun that follows the overall market and if i wanted to protect my portfolio against a stock crash i could buy puts for that 350 dollar strike price here for about 11.75 each if the s p 500 falls from here falls below that 350 dollar price per share on the spy fund then i'll profit off that position which is going to help offset some of those losses on my individual stocks and you can use these strategies you can buy puts against your stocks or the market at any time when you buy the stock or even later so it's really a great strategy for protecting near-term risks whenever you see them if a stock price falls below your put option price you locked in that floor price if the stock price doesn't fall then you still benefit from the upside and the shares you're going to lose out on that premium that you paid for the puts but that's just the cost of insurance in fact that's really the best way to think about this protective put strategy as a classic insurance play you're paying a premium a price to buy those put options and they protect you against the possibility of large losses and like a lot of these options trading strategies your biggest decision in this is going to be at what strike to buy and what expiration date do you want protection further out so buying the puts that don't expire for many months or even a year you'll notice that the cost of protecting my portfolio against a market crash below that 350 strike price on that spy fund to january so just for the next two months it's only going to cost 11.75 cents a share but if we want to go further out for protection out to june of next year then that same strike price of 350 dollars is going to cost me 23 dollars per share also asking yourself do you want that protection very close to the current price or are you willing to see some losses on the shares for a cheaper premium price now you see the price for protecting my portfolio around the 353 current price on the spy that's those put options are about 12.77 each but if i'm willing to take a little bit more risk and only protect myself under maybe a 348 dollar strike price those options are much cheaper at just 10.86 per share so you see playing around with these two questions is going to lower that premium on the insurance so though at a little higher risk or it's going to increase the premium and give you less risk in that trade it just depends on how far out you want to protect your stocks or your portfolio so when do you see those major risks in the market and how big of a risk are you forecasting so how much downside protection do you need and here's that profit and loss diagram on those protective puts this one is an example where you're buying the stock at a price of 15.84 and then buying a put at that 15 strike price for a dollar 46 cents each and they're now here starting towards the bottom you see how this strategy totally limits your downside the maximum loss you're going to see here no matter what is going to be that 15 floor that you sell the stock for with that options minus the money that you paid to buy it or that dollar 46 cents per share so let's just say this stock crashes five dollars a share or something right you can still sell it for fifteen dollars a share because you've got that put option now here you've only lost the 84 cents which is the 15.84 cents that you paid for the stock originally minus the 15 strike price on the put option and then plus the dollar 46 cents that you paid for the right to sell it at that price now your break even price is a little higher here because you bought that insurance policy instead of the 15 and 84 cents price that you paid for the shares it's that plus the insurance premium of a dollar 46 that you paid for the put option as well that means your break-even price for this investment is now going to be 17.30 a share but see the great thing about protective put strategies versus the covered call one is that you have unlimited upside potential even though you had to pay for that premium to buy the put options you'll continue to benefit if the stock price moves higher so your return isn't limited like it is with covered calls spreads are another great option strategies i've used a lot and helps you cut costs to using these options and spreads come in two types a bowl or a bear spread is where you buy and sell the options within the same month a calendar spread on the other hand is where you buy and sell options from different months and spreads work so well because they fix one of the biggest problems with options trading that cost of the premium look at our january tesla options again if you thought the stock might go higher then you'd be tempted to buy those call options you could buy the call option with a 420 strike price but they're going to cost you 44. each at that price the stock would need to rise to sit 464 dollars or about 10 percent just to cover the cost of the option premium but with a bull spread you buy the call at the lower strike price and then sell the one at the higher strike price to help offset that here if you buy the 420 strike for that 44 dollars then maybe you sell the 435 dollar strike option for 37.15 so you're buying one for 44 dollars and selling another for 37.15 against it for a net cost of six dollars and 85 cents for each spread and what happens here is you make money on your 420 dollar call options at a strike price is above that point now if the shares rise above 435 then you're going to start losing money on the call options that you sold but those are totally offset on a one-to-one relationship with that other option you've got a space there of 15 where you're making money on one and not losing anything on the other but just some easy math here say your max gain is 15 per option and that net cost is 6.85 cents each that means a potential 119 return if shares of tesla reach 435 or higher by that expiration date now let's do a bear spread example and then we'll look at those calendar spreads so if i thought tesla shares were overbought or might fall i could buy the puts for 415 strike price for 39.25 each again though because shares of tesla are so volatile that's an expensive bet just buying the put option here means that shares have to fall to 375 dollars each just to make money on that trade now the put option is going to be in the money when the price falls below that 415 strike price but because i had to pay the 39 premium for the option my actual break even price is about 10 percent lower but with a bare spread here i can cut the cost of that trade i can buy those 415 strike put options at a 39.25 premium and then sell the 405 dollar put options the strike price at 405 dollars for that 36.35 for a net cost of 2.90 each and just to do the math on these all you have to do is look at the net cost and the spread between these stock strike prices the spread between the 415 put and the 405 dollar put option is 10 which is my maximum gain so my max return here is ten dollars divided by that net cost of two dollars and ninety cents each or a two hundred and forty four percent return so using spreads like this enable you to cut those costs of trading options and still potentially get a great return if the stock price goes your way now of course the downside to all this is you limit your return if you had simply bought that 420 call option on tesla and shares had jumped 30 to 550 each your option would then be worth 130 or 195 return on the premium that you paid but that's a long way to go and a very expensive option to buy now if we look in my portfolio this is actually one of the bull spreads that i bought buying the 170 dollar call on shares of boeing for about twenty one dollars and five cents and then selling the hundred and eighty dollar strike for seventeen dollars and eighty five cents or a net cost of three dollars and twenty cents each now the idea here is that with the potential for a vaccine or just some talk out of washington for a stimulus deal there are a lot of ways that boeing can jump back over that hundred and eighty dollar share and you see here it did just that in early november i made over five thousand dollars on a single day and could make as much as 6 800 on the trade and here's the profit and loss diagram on a bull spread and with the example of buying a call at a 15 strike for a dollar 64 and then selling the 17 call for 51 cents or a net cost of a dollar 13 each now pay attention to this solid line here we won't worry about the dash line that's a different scenario so the max loss you can have on the spread is that net cost that dollar 13 that you spent total that's where the graph levels out here on the left at any price under fifteen dollars so under that bottom call and strike price that you bought you lose the entire investment here now anything between that fifteen dollars to the seventeen dollars though is where you start making money you're gonna break even if the stock reaches sixteen dollars and thirteen cents a share because because that's the fifteen dollar call option the strike price plus the dollar thirteen net cost that you spent on the spread now anything over that and up to seventeen dollars per share is your profit and max profit here is 87 cents a share at a price of that 17 per share now that's where the line flattens out on the right here any price above 17 you're gonna cash out the two dollars per share for an 87 profit now a calendar spread is the same concept except you're using it for different months for example maybe you're long-term bullish on tesla but you think the short-term it might not do much and you want to cover your long-term costs you can sell the january 420 strike call options for 44 dollars and then you go out to a later month here you've got the january 2022 options you can buy the 420 call options here for 115 each for that net cost of 71 each now if shares of tesla start climbing immediately both of these call options are going to rise in price that means you're going to be losing money on those january 2021 calls that you sold but you'll also be making money on the 2022 calls that you bought so a lot of that is just going to cancel out the best case scenario here of course would be if your stock price went nowhere closed out under the 420 each in january so those call options that you sold are expire worthless you would then keep that 44 premium that you made from selling that call option and would have still have this 2022 call option for another year waiting for the shares to move higher these are a little riskier than the other types of spreads and i don't use them often for example if the shares jumped immediately you might lose money on that near dated option that you sold and then maybe six months down the road if the stock price falls hard you could be losing money on that long dated option as you bought as well this is why a lot of times investors are going to keep selling those new call options on the position each time an earlier one expires so after that january 2021 call expires they'll sell another one maybe march 2021 option while they're still holding that 2022 option option straddles here are really cool because you're not betting on a direction in the price instead you're betting on the volatility of the price of the stock a long straddle is where you buy a put and a call at the same stock price and the idea here is that some event or news is going to move that stock price in a big way and this is one example where it's actually easier to look at that profit and loss diagram first to understand this in this example you buy a call option at that fifty dollar strike price for two dollars and twenty nine cents each at the same time you buy the put option at the same strike at that fifty dollar strike price for two dollars and twenty eight cents each so your net cost for this straddle is what you paid for each option in this case that's the 229 for the call option and the 228 for the put for a total of 4.57 each now here you see you're gonna start making money as long as the strike price is above or below fifty dollars each so let's say these are shares of american airlines and a vaccine is approved that sends the shares up to sixty five dollars each you would make nothing on the put options because the stock price is now above that fifty dollar strike price but you make fifteen dollars on the call options for a net gain of ten dollars and forty three cents each or a two hundred and twenty eight percent return on this trade conversely let's say hope for a vaccine fades away and the shares tumble to thirty five dollars each in this example you make nothing on the call option because the shares are now below that fifty dollar strike price but you make the difference that fifty dollar strike minus the thirty five dollar current price on the put options for the same fifteen dollar payoff you make the same net gain that 10.43 and that 228 return so with a straddle here you're betting that the share price moves one way or the other in a big enough move that it's going to cover your total cost in this example with the net cost of buying that put and the call option for four dollars and fifty seven cents each the stock price has to be below forty five dollars and forty three cents or above fifty four dollars and fifty seven cents before you start making a profit on the trade so here you're going to want to use a straddle when you think some news or event is going to cause a big swing in the price you just don't know which direction it's going to be for example maybe a lawsuit decision is expected and it could spark a relief rally or really hit the shares heart or a lot of investors are going to trade option straddles around those earnings events expecting surprise earnings to drive the shares higher or lower now the problem with the straddles options strategy is that everyone is looking at these same events and making their bets if a lot of investors think that earnings or some expected news are going to drive a big change in the shares then there's going to be a lot of volatility in that stock and that's going to mean really expensive option premiums for example if we look at our january tesla options maybe we think old elon is going to take to twitter again and move the shares in a big way in january either higher or lower so we buy that strike calls for 44 each and then by the same strike puts for 42.70 each or a net cost of 86.70 each that means shares of tesla need to rise either above 508.77 or fall below 335 each by january just for us to start making money on this trade strategy that's a 20 move either way so it would have to be a pretty crazy tweet now in truth since the price on these options change as the price does you can actually make money on these if the price moves up or down quickly even in say a five or ten percent move just just a big move if there's still some time left in these options it's going to move the prices and you'll usually make more on the profitable side than you're going to be losing on the other side so a slight profit you can collect our last options trading strategy here is called collars and then i'm going to show you how to pick which of these strategies you want to use callers are a great way to protect your downside but at a lower cost than a protective put strategy here you own the stock and you buy that in the money put so a put option above the current price but then sell a call option at a higher strike price to offset some of that insurance cost and let's go back to our tesla options for an example you buy the stock at 422 and are a little worried about the near term but you really don't want to pay almost 43 dollars for the put options with a strike of 420 per share now remember this would be the protective put strategy you own the shares and buy a put that gives you the right to sell the stock at that price now you know you'll get at least 420 a share no matter what the stock price does because you bought that put but you had to pay that big premium to buy it well with a caller you would sell a call option at a higher price to offset some of that premium some of that insurance cost here if you sold the calls with a 435 dollar strike price you would collect 37 and 15 cents each to offset that 42.70 that you paid for the put or a net cost of five dollars and 55 cents each now let's think about what this means for the stock if the shares fall we can use that put to sell it for 420 each we've locked that in as our lowest price that we'll get from the shares now at that price the call options we sold would expire worthless so we keep that money and we're protected on our downside now conversely if the share price stays above that 420 each our put option is going to expire worthless we wouldn't use the put to sell our shares for 420 each if we can just take them to the market price and get more for it we still have that call option that we sold though so if the price rises above 435 dollars each then that investor is going to buy our shares for that price basically we've locked in a max gain on our shares of 13 each because we bought at 422 dollars and then sold the call option at 435 each in fact though our actual cost on the shares is a little higher because remember we had a net cost of 5.55 cents we paid for that put protection the caller profit and loss diagram here will make it a little bit clearer in this example we've bought the stock at 12 each and bought a put with a 15 strike price for a dollar forty six cents each and sold the seventeen dollar calls for a dollar forty four cents so that put and call price almost cancel out each other exactly now in this scenario if the share price falls below fifteen dollars each we can use our put option to sell it for that price and still make 2.98 profit that's the difference between the 15 sell price that put option strike price and the 12 that we pay for the stock but then minus the 2 cents per share that we paid for the puts and the calls on the other hand if the share price jumps beyond 17 each the investor that bought our call option would get our shares for that price in this case we have a profit of 4.98 per share or 17 minus the 12 that we paid and then the 2 cent per dollar cost now like a lot of these it might take a couple of times to really understand what's going on with the strategy basically you're locking in a minimum and maximum profit with your stock and with any of these you can experiment with how you're buying and selling different strike prices to change your profit or loss potential now that we have the options trading basics and those five strategies i want to show you a handy little table to help you decide which strategy you can use depending on your perspective on a stock now when you go to use an options trading strategy you're primarily asking yourself two questions what direction do you think the stock price will go higher or lower and will that direction happen quickly or will it take a while in other words will the stock price become more or less volatile this volatility is important because it affects the price of those options if a stock price is jumping around a lot options both higher and lower are going to have a better chance of making money so investors that have to pay more for that opportunity so here you see in this table your outlook on the price can be bearish meaning you think it's going to go down it can be neutral or that kind of stuck in a range or you might be bullish on the stock you think the stock price is going to go up on the left side of the table is that volatility decision you might think the volatility is going to decrease so maybe the share price doesn't jump towards the price direction but but slowly just builds to it or conversely maybe you think volatility is going to increase so the stock price jumps higher or lower quickly or just whipsaws back and forth a lot now your answer to just these two questions is going to tell you which of these five options trading strategies to use for example if you think shares of a stock are heading lower and volatility will decrease you can write call options on your position with that covered call strategy someone is going to pay you a premium for those calls and as the stock price drifts lower and volatility decreases those call options are going to become less valuable you're going to keep your shares and the difference in price on that sold call if on the other hand you think the share price could fall faster you might just buy puts for that protection to lock in the lowest price that you're going to get on the stock you could also just buy puts without even owning the stock if you want to profit from that crash in prices now if you're not sure where the stock price is going to go maybe it's going to stay in that range or there's an equal possibility of it going higher or lower but news or events are likely to make the share price volatile so here we're in the middle column or that top or the bottom then you'd want to use that straddle option strategy if you think the volatility is going to increase you buy a straddle and wait for the volatility to make both that put and call options more valuable potentially profiting on both if on the other hand you think maybe volatility is going to decrease in the shares you can sell a call and a put option for what's called a short straddle as the stock volatility decreases both of those options are going to become less valuable and you can buy them back for less than you sold them for again for a profit on each you can use the bowl or bear spreads on either side here really whether you have a bullish or bearish perspective the change in volatility doesn't matter quite as much with this one you're just betting on the direction of the stock and lowering your trading costs collars and protective puts are going to work best when you have that bearish or a neutral outlook on the shares and want that downside protection nation this is not something you're going to pick up immediately and become an options trading professional but i promise give it some time watch these strategies again and you will make money on these options tradings can be a powerful tool if you use them right it can help you reduce your risk and increase your returns all you need to do is understand which strategies you use and when click on the video to the right for the 10 financial ratios that every investor must know check out that playlist for all our videos on that how to invest playlist and don't forget to join the let's talk money community by tapping that subscribe button and clicking the bell notification

Channel: Let's Talk Money! with Joseph Hogue, CFA

Views: 128,254

Rating: 4.9504838 out of 5

Keywords: options trading, how to trade options, trading options, options trading 101, put options, call options, what are options, how to buy call options, how to buy put options, options trading strategies, options trading for beginners, stock options explained, options investing, stock options trading, investing in options for beginners, options trading basics

Id: owZNEuYL_N0

Length: 53min 43sec (3223 seconds)

Published: Fri Jan 01 2021