by Chris Rowe 08/19/08
HOW DO I MAKE MONEY WITH IN-THE-MONEY OPTIONS?
So, when you are shopping for options, look for one that has very little time value in it due to the fact that it is "in-the-money."
The way to find a put option that is in-the-money, and by how much, is to first look for put options that have a strike price that is higher than the actual stock price. (If the strike price of a put is lower than the market price of the underlying stock, it is not "in-the-money" -- it's "out-of-the-money.")
Then, subtract the stock price from the strike price of the option. In this case, with XYZ stock trading at $40, we would look at buying the XYZ April 45 Put since that strike price ($45) is higher than the stock price.
Since the option is trading at $5.65, we know that the remaining 65 cents is the time value (extrinsic value).
The idea is to use a put option that has very little time value so that your trade is almost solely affected by the stock's price movement and not time deterioration.
Your put option will lose its time value as you get closer to the expiration date. Picking a put option that will give you twice as much time as you believe that you need for your position to work out is also usually a wise idea, since trades often don't go exactly as you expect them to, so you want to have a (time) cushion.
In the example above, with an April 45 Put trading at $5.65, the most I stand to lose is 65 cents (my time value) if the stock trades flat during the coming months. That's a small price to pay for all of the benefits that come with this strategy.
If the stock trades up to $70, I only lose $5.65 per share (the value of the put option) rather than losing $30 per share (the difference between $70 and the price at which I would have shorted the stock, which was $40).
If you read this over and over and you search around on the internet and learn about this technique, it will be more than worth your time. It may save you thousands, or millions.
Think of how many hours you work each day to earn the money that you are investing. If you could save yourself 25% of the value of your stock portfolio, divide that value by how much you earn per hour. Is it worth spending a few hours to understand this?
Once you are familiar and comfortable with it, it's your knowledge to keep for the rest of your life.
Chris Rowe is the Chief Investment Officer for Tycoon Publishing's The Trend Rider. To learn more about him, click here to read his bio.
If you enjoyed this article from Chris, you may also want to check out his thoughts on the "Benefits of Buying In-the-Money Call Options" and "Success With Naked Puts."
Sam Collins
FAST is now consolidating and recently flashed a buy signal from our internal indicator.
Options Expiration Adds Volatility
The opening looks to be higher but today is options expiration day, and anything could happen.
Chances are high stocks will sell off further, but be alert for a dead-cat bounce after such a dramatic breakdown.
Traders and longer-term investors should sell any new positions at the first opportunity and short ETFs on a temporary recovery in the market.
CAT, the blue-chip of its industry, is the first to attract attention when it's time to dress up a portfolio.
