Someone asked how I trade options, and here it is. My technique doesn't provide huge returns, but it seldom loses money either.
I move a fair amount of my money into deep in the money calls (Jan18 100s, for example) when the stock price is fairly low and then when the price goes up and we get near a peak I sell the calls over some time and use the money to buy shares of TSLA. Sometimes when I'm pretty sure we're going to go back down a bit, I don't buy as much stock and hold some cash. I get about 2 to 1 leverage over stock by buying deep in the money calls for a future year, but by deleveraging by selling the calls and buying shares as the stock price approaches what may be a peak, I reduce my exposure to falling stock prices and in so doing I can make money on the ups and downs, even if we end up at the same point on each peak. The main advantages of such a conservative trading style is that 1) I'm usually "all in" and don't miss unexpected runs up, and 2) I'm very well positioned for rolling my leaps forward if Tesla isn't doing well. For example, if you owned Jan17 100 calls, you could sell these for about $118.50 apiece today, and the cost to buy Jan18 100 calls right now is about $121 apiece. The difference in price between Jan17s and Jan18s is only about $2.50, and so I would by now have added a little money and rolled my Jan17 100s into Jan18 100s. If we have a surprise and selling the Jan18 100s does not look good in 2016 or 2017, I can always sell them and roll them into Jan19 100s for very little money.
Actually, I seldom need to add money to roll deep ITM leaps from one year to the next because I use rising or falling share prices to do that. Often we get caught in a cycle where TSLA is heading up or heading down. When it is heading up, I will use some of my liquidity to buy 2 Jan18 leaps and then when my Jan17s reach the same value as what I bought the Jan18s for, I sell the Jan17s. It's even better when TSLA stock price is heading down, because I sell 2 of the Jan17 leaps and then wait for the price of the same Jan 18s to be reached and then buy 2 of them. If I think the stock price will continue down I sell 2 more Jan17s and hang loose until I can buy Jan18s for the same price.
Trading most options is an easy way to lose money if you are not careful, or if the stock price hands you a surprise. If you are considering options for the first time, here are a few terms you need to know.
Strike Price: The underlying value of an option. If you bought a Jan 18 100 call option ($100 is the strike price) and on the morning of the date in Jan of 2018 when the option expires the stock is trading at $250, that option has a theoretical value of $150 when it is "exercised" ($250 - $100 = $150. Note: most traders don't exercise options with a market maker. They sell the option instead at market price.
Expiration Date: Some options are good for only a week, some for over a year. The expiration date is the last date that the option can be exercised. Obviously, options with later expiration dates are going to have a higher market value. When we call an option a Jan 18, we really mean it has an expiration date in January, 2018.After the expiration date, your option becomes worthless, even if it had value the day before expiration.
Market Value: This is the price that the option is currently trading at (approx. $121 in our example)
Time Value: This is the difference between Strike Price+market value of the option and the current market value of the stock. In our example, $100 + $121 = $221. TSLA stock is trading for $218. Therefore, TIme value = $3. Another way of looking at time value is that this is the amount the stock would have to rise in price in order for you to break even exercising it on the final day of the contract. So, TSLA would have to go up $3 between now and Jan 18 for you to break even on this trade (commissions not considered).
Let's take another example. Right now TSLA Jan18s with a strike price of 200 trade at about $52. If we add strike price to market value we get $200 + $52 = $252. With the stock currently trading at $218, we would need to see TSLA rise to $200 + $52 = $252 by January of 218 for you to break even selling the stock on the final day of the contract. The time value would be the difference between the $252 and $218, so you would have a whopping time value of $34. You can see there's lots more leverage buying an option that is close to the trading price, but you need to either see it go up in value fairly quickly or you need to see lots of appreciation if you want to make money selling the option close to its expiration date. The time value of an option decreases with time and is close to $0 on the final day of trading before expiration.
A Call Option: When you buy one option, you are actually buying the right to trade the equivalent of 100 shares. Thus, a single option with a market price of $121 sells for $12,100 plus your usual brokerage commissions. If TSLA goes up $1 during the day, your Jan18s call option would increase in value close to $1 x 100 = $100. On the other hand, your 200 strike price call option would appreciate less than $100 because some of the rise has been absorbed by time value.
Personally, I suggest if you've never traded options before that you start very small and buy a conservative option such as a Jan 18 100 strike. Keep most of your money in stocks as you slowly learn about the good and bad of options. The good: you get more leverage and can make more profit from the same investment if things go well. The bad: you can lose your entire investment in the option if things go poorly. For example, if TSLA falls below $200 in value, your $200 strike price option (if you opted to buy that one) would have very little value as expiration date approached. Thus, they're less forgiving than stock, and they have a time limit, which stock does not have.
Buying or selling an option: There are far fewer options traded than shares of stock. Some days, not a single TSLA Jan18 100 trades. Take a look at the bid and ask prices of an option. You might see sellers asking $123.95 for Jan 18 100 and buyers offering $119 for those options. The price you buy at will be somewhere in between. Midway sometimes works, but you might be paying too much if there are 80 options offered at $123.95 and only 4 buyers bidding $119. In such a case, I'd try to buy at a little more than $119, but not midway between the two numbers. It's a frustrating experience at first, because if you bid $119.50 you might see some buyers upping their bids to $119.50, too. It takes practice and sometimes patience to buy an option for the right price, and sometimes you have to walk away if the sellers are not budging from asking prices that are just too high.
Anyway, for those of you asking how I trade options, that's it in a nutshell.
