By: Tom Gentile
on January 1st, 2021
Options trading is a way to enter an unpredictable market. Some benefits associated with this method are reduced costs and risk. An option controls 100 shares of stock for a fraction of the money needed to buy or short the stock.
Types of Options
The two types of options are Calls and Puts. The value of a call option increases if the stock increases. The value of a put option increases if the stock decreases. Calls are bullish instruments and puts bearish.
If you buy a put option on the SPY and the SPY drops, your put option increases in value.
Two important questions must be answered before buying a put option:
- What strike price?
- What expiration date?
A strike price is the price at which you control the stock. The SPYs have many strike prices to choose from and picking the “best” one is easy, when you know how. The option chain below shows a handful of them:
This table shows strike prices down the middle, calls on the left and puts on the right.
The strike price closest to the stock price are called “At-The-Money” (ATM). For calls, strike prices greater than the current stock price are called “Out-of-The-Money” (OTM). Strike prices less than the current stock price are called “In-The-Money” (ITM). The opposite is true for puts.
For the best “bang for your buck,” buy slightly OTM options. These options will generally provide a greater return than the other available strike prices.
Buy options that are 1-3 strike prices OTM, but don’t get too fixated on picking the “best” one. All strike prices will generate profit if the stock moves your way.
After you’ve determined which strike to buy, you need to decide which expiration to buy. Currently, the SPYs have many expiration dates to choose from. The simplest answer to this question is to buy options that expire within 30-60 days.
In the example above, we’re splitting the difference with a 45-day expiration date. Here’s a great way to profit if the prognosis is correct:
Buy 1 x SPY Apr 16, 2021 $385 Put. This put option is currently listed at $9.53. Given that one option controls 100 shares of stock, this trade will cost you $953. This is also the maximum risk in the trade.
If the SPYs drop, this put option will increase in value. Consider selling the option if it increases in value by 50-100%.