by Ken Trester 05/12/08
While inexpensive option prices might get your attention, it's important to remember just how much stock you are actually controlling at any given time. Just because an option seems inexpensive doesn't mean you should get too wild and crazy.
You may see an inexpensive option and think, "Hey, that option over there only costs 80 cents ... I think I'll buy 40 contracts."
The $3,200 you spend on that one trade might seem like a small amount to you to invest, but remember you are actually controlling 4,000 shares of stock (as 40 contracts times 100 shares controlled per contract equals 4,000 shares).
If, in your right mind, you wouldn't normally trade so many shares of stock ... well then, don't buy so many doggone options!
I LOVE CHEAP OPTIONS MYSELF, BUT THEY HAVE TO BE THE 'RIGHT' ONES
The beauty of trading options is that you get an incredible amount of leverage for a relatively small investment. If you really wanted to control 4,000 shares of stock, indeed buying 40 options contracts is a great way to do it, compared to the cost of buying that many shares outright.
Those 80-cent options might be cheap because their chances of becoming profitable are a long shot at best. If the underlying shares are trading at $25 and you buy a call option at the $40 strike price, with an expiration date coming up in two months, what are the chances that the stock will rally $15 in that time period?
If there are a number of upcoming positive catalysts (i.e., a good earnings announcement, several product launches, etc.) in that time frame, the stock might have a shot at spiking $15. But for the most part, you should focus on more-realistic expectations and choose the best options to trade accordingly.
In reality, those options are probably not going to become profitable, especially when you're expecting such a big move from the stock in such a short time frame!
LESS IS MORE -- IT'S NOT A CLICHE IF IT'S TRUE!
Now, we all want to win, and we trade in the options markets to do just that. But while a win on that size investment would be sweet indeed, being forced to take a loss -- no matter how small -- could make even the most-confident trader become gun-shy when it comes to putting on the next trade.
Thus, it's best to remember, from time to time, what you're actually controlling and the amount of stock underlying your actions. The goal in this game is to live to trade another day, and the nature of options is to spend a little bit of money to gain a lot of leverage.
You can buy as few as one or two option contracts when you're getting started -- take advantage of moderation and don't be blinded by what looks to be a bargain-basement price. Remember, there might be a good reason that it's not worth very much!
You can make some of your biggest returns with underpriced options (i.e., those that haven't been priced at their full, expected value yet). Once you've gotten the "right" ones to trade, then what? For starters, click here to read about how to "Make Big Money in Underpriced Options."
Trade Options With 'Fun' Money
Options can be so inexpensive, it's hard to remember that you're playing with 'real' money.
Boring stocks are for buy-and-hold investors. When you're buying options, you want stocks with some serious 'get up and go.'
Selling Options Can Generate Instant Profits
Not only can you buy options, you can also sell them as a way of establishing a position.
Generate Substantial Returns with Smart Bets
The less you spend on your options trades, the bigger your profits can be. Today we talk about how to get big payoffs for less money.
