I’m primarily an index fund investor, but I think that investing should also be fun. I personally have a “sandbox” account that I use to invest in individual stocks. Assuming you are investing enough in broadly diversified funds, maybe you’d be interested in trying out some other forms of investing (it’s usually recommended to use no more than 10% of your money on individual bets), if for no other reason than to have some fun and learn more about the market. It’s possible that you develop a new skillset or expertise that will allow you to make more in the future.
I’ve been investing for about 13 years, but I didn’t start trading options until about 4 years ago because they seemed complex and risky. While there are many complex strategies associated with options, an option is essentially a contract to buy or sell 100 shares of a stock by a certain date. I found that focusing my purchases on calls and puts (option to buy and sell 100 shares respectively) helped to simplify trading and reduce the risk while I was still learning about options.
Over my options trading “career” I have earned my MBA in finance along with my Series 7 & 66 license. So, for those looking to take the next step beyond basic stock trading like I was, here are a few tips for options trading that I learned.
Create a Watch List
Not just any watch list though. As the venerable Warren Buffet has recommended, only invest in the businesses you are familiar with. Therefore, create a watch list of approximately 10-15 publically traded companies that you know/value the products and services they provide. For me, that is companies like Tesla (TSLA), Apple (AAPL), Starbucks (SBUX), and Verizon (VZ).
Take TSLA for example, I don’t drive a Tesla, yet, but I have been following TSLA for several years and from what I have seen they produce superior products and will become cheaper to produce as time goes on. That is why I have them on my watch list and I have purchased several options of theirs.
Do Your Research
Once you have your list together get to know how the stock and the company have been performing, what people are saying about it, and what its future prospects are looking like. I know the value of a company should only be determined by logic and the expected future cash flows but, in reality, emotions come into play quite a bit, so news and sentiment associated with the company can play an important role in its stock price. Therefore, it is just important to understand the financials of a company as it is to understand the “mood” surrounding the stock itself.
Using TSLA again, I found their business model to be potentially lucrative and that people who follow the stock either hate or love the company. This makes the stock particularly volatile based on the most recent news and reports associated with the company.
Wait for an Opportunity
When purchasing calls and puts individually it doesn’t make sense to purchase those options on a company that you think is properly valued because there isn’t an opportunity for the option to increase in value if the stock price doesn’t move. The two factors that influence my options purchases include finding companies that I believe to be over/undervalued and perceived overreactions to news that cause a stock to become over/undervalued. One of the mistakes that I have made is that I would make trades because I was bored and didn’t want my money sitting there doing “nothing,” but there wasn’t a real opportunity and I was basically gambling rather than investing. Therefore, I’ve set up a few ground rules for myself, which I will explain in later posts, that help me determine when I should/shouldn’t invest.
By the time my next options post is published, I would challenge those who desire to break into options to create a watchlist and do some research on those companies because my next post will go more in-depth on identifying and utilizing opportunities.