How to Win with Options
Source: Kevin Matras, Zacks Investment Research (11/15/11)
"Options give the investor numerous ways to make money in the market—and in any direction."
In fact, more and more investors are using options in their trading as a way to beat the market. In fact, the number of options contracts traded has set an all-time record.
Whether that's because of the recent market volatility or in spite of it, options can provide staying power.
Plus, options are flexible. You don't need a lot of money to get started. And it's a lot easier than you might think.
One of the key advantages with options is you can make money if a stock goes up. You can make money if a stock goes down. You can also make money if a stock goes sideways. In fact, with some strategies, you can even be wrong on a stock's direction and still make money.
Of course that doesn't mean you can just close your eyes and pick anything. But it does mean that you can make money in virtually any market condition—even when you're unsure what the market will do.
Another advantage with options is leverage. You can get started in options with only a fraction of the money you would normally have to invest to get into the actual stock itself. And many strategies come with a guaranteed limited risk.
It's these advantages—and more—that can make options a perfect addition to someone's portfolio.
What's interesting, however, is that even though the popularity of options has soared, they are still not as well known or as well understood as stocks. But they should be.
If you're bullish on a stock, you can buy a call option and make money as it goes up.
Momentum stocks and aggressive growth stocks are probably the best kinds of stocks to use for this. These are stocks that are on the move, with some of the most explosive upside potential.
When buying call options you need to be right on the direction of the trade, as well as the time allotted for it to move. Add in the Zacks #1 Rank (strong buy) and these are some of the likeliest candidates to profit with this strategy.
If you're bearish, you can buy a put option and make money as the price goes lower.
Look for stocks trading at excessive valuations. Focus on the ones with downward earnings estimate revisions. If they are below their major moving averages, like the 50-day and 200-day moving averages, even better.
With put options, direction and time are important as well. Stocks with a Zacks rank of 4 or 5 (sell or strong sell, respectively) will typically underperform the market over the short term, which is perfect for this strategy.
Big Move in Either Direction
If you believe a big move could occur in either direction, but you're not sure which way, you can make money with a straddle. This entails buying both a call and a put at the same time.
One of the best times to use this strategy is before an earnings announcement. And some of the best stocks for this option strategy are high-beta stocks. These are stocks that can move big, and that's exactly what you need to see happen with this kind of strategy.
Once again, in order for a stock to make a big move, there usually needs to be a catalyst. Among the most reliable catalysts out there for big moves (up or down) are earnings reports. If you also take a look at the stock's "earnings uncertainty," you have the potential for the kind of volatility to make a strategy like this work.
Slower, Moderate Move
If you're expecting a stock to go up or down, but you expect the move to be moderate, or slower, then spreads are a great strategy.
For example, a bull call spread involves buying a nearby strike and selling a farther-out one. If the stock goes up, but slowly, the nearby call you bought should increase in value, in spite of some time-decay loss. But the call option you wrote will benefit from time decay, thus making the spread more profitable than had you only purchased a call.
Value-style stocks and even growth-and-income stocks can produce some good picks for a bull call spread strategy. Stocks are expected to move higher, but maybe not with a big splash. Zacks #2 Ranks (buys) and Zacks #3 Ranks (holds) are good stocks to consider for this strategy.