Options are a type of derivative, meaning they “derive” their value from the securities to which they are linked. Options are also leveraged, meaning a smaller amount invested in them can generate larger gains — or losses — than simply buying the underlying security.
For example, if you think Tesla stock is about to make a huge move up, rather than laying out $20,000 or more per share to buy 100 shares of the stock, you can spend perhaps $200 per option to gain the same amount of exposure. These trades have very different risk profiles, but the amount of capital needed reflects the leverage involved.
Can Options Trading Make You Wealthy?
Yes, options trading can make you a lot of money — if you understand how it works, invest smart and maybe have a little luck. You can also lose money trading options, so make sure you do your research before you get started.
There are two primary types of options: calls and puts. In their most basic form, a call option gives you the right to buy 100 shares of an underlying stock at a given price by a given date, while buying a put option works in the opposite manner: You can sell 100 shares of the underlying stock at a given price by a given date.
Beyond these basic definitions, however, there are various ways you can buy and sell options. Over time, you may look to employ some more intricate options strategies in your quest to get rich. Here’s a quick overview of some of your choices, along with some basic but essential information about options in general.
1. Buy Puts
Buying a put is a way to bet on a stock’s price falling. Rather than having to sell a stock short, you can simply buy a put and profit if its share price drops.
For example, let’s say that you’re bearish on Tesla stock and think it will drop from its current level of around $200 per share to $150 in the near future. You can buy a put option on Tesla with a strike price of, say, 200 for perhaps $20 per option. If the stock does fall to $150, the intrinsic value of that option will shoot up to $50, in addition to whatever time value remains.
2. Sell Covered Puts
Selling a covered put is a way to generate income from an existing short position. If the stock does nothing or goes down slightly, you’ll get a boost in profit from the premium you receive for selling the put. The risk is that if the stock instead rises sharply, it will result in a loss for you. However, the loss will still be less than if you simply held the short position outright.
3. Sell Naked Puts
Selling a naked put is an aggressive bet on a stock rising in value. By selling a naked put, you are giving the purchaser of your option the right to force you to buy the stock at the strike price at any time. If the stock falls to zero, for example, you’ll still be forced to buy the stock at the strike price.
But if the stock rises, you’ll get to keep the premium you received without any further repercussions.
4. Buy Calls
Buying a call is the simplest way to profit from a speculative trade. Imagine Tesla trades for $185 and you buy a call with a strike price of 200 for $20. If the stock rises to $400 per share, the intrinsic value of your option will rise to $200, plus any remaining time value. While stock investors will have made a 116% profit, you will have earned at least 10x your money.
5. Sell Covered Calls
Selling covered calls is a more conservative option strategy that carries lower risk and lower reward.
When you sell a covered call, it means you sell a call against a stock that you already own. You receive the premium from that sale as income. If your stock falls or does nothing, you simply profit from the sale. But if the stock rises, you may lose out on some potential upside as your stock gets called away from you by the purchaser of the option.
6. Sell Naked Calls
Selling a naked call is the riskiest strategy possible in the options world, as it subjects you to a theoretically infinite loss. You’ll profit by keeping the premium you receive from the sale if the stock remains the same price or falls.
However, if it rises, you’ll be forced to buy the stock in the open market at the current price to provide it to the buyer of your call option. As a stock can theoretically rise to any price, you may be forced to pay a huge amount to buy that stock and fulfill your obligation.
7. More Exotic Strategies
While you can certainly “get rich” by trading options in these most direct ways, there are also more complicated strategies employed by professional options traders that may enhance your return potential and/or reduce your risk. These methods go by such exotic names as “spreads,” “straddles,” “strangles” and even “The Iron Condor.”
Before you begin trading these more advanced options strategies, be sure to consult with a financial advisor regarding their appropriateness for your portfolio and risk profile.
How Do Options Get Their Value?
In one sense, options are essentially “made up” securities. The only reason they have any value at all is that they confer certain rights associated with a different security.
The options price you see listed in the active market is a combination of an option’s “intrinsic” and “time” value.
The intrinsic value of an option is the amount that it is “in-the-money” in relation to its strike price. For example, if you own a Microsoft call with a strike price of 200 but the actual market price of Microsoft shares is $250, you are “in the money” by $50. This $50 is the intrinsic value of that call option.
But since options also expire at a set date in the future, they also have a time value. The longer an option is dated, the greater the time value it has, as it gives the stock a longer period of time to get “in the money.”
Imagine that you and your friend both have Microsoft call options with strike prices of 200. Your option expires in April, but your friend’s doesn’t expire until December. Which option would be more valuable? The one that affords Microsoft stock the longer time to climb above $200 per share. Thus, the time value of your friend’s option would be significantly larger than yours.
What Are All the Numbers Associated With an Option?
If you’re looking to buy or sell an option, you might notice that there is both a month and a series of numbers associated with each option. For example, you might see a stock call option listing that looks like this:
- MSFT JUL 200 83.08
This means that you can buy one call option on Microsoft stock that expires on the third Friday of July for $83.08.
As each option gives you the right to control 100 shares, that $83.08 price will actually cost you $8,308. The “200” figure is the strike price, which is the price that you will have to pay if you want to exercise your call option. In addition to the $8,308, if you want to exercise that call option and buy 100 shares of Microsoft, you’ll have to fork over an additional $20,000, or 200 x 100 shares.
Employing these seven options trading strategies — and understanding the market — can make you rich. Just remember that no investment is without risk. If you’re interesting in trading options, you should consult with a financial advisor about your risk tolerance and financial goals first.