Today, we’re going to be talking options.
Well, options provide us with leverage… and sometimes, it’s more advantageous to trade options than to buy the stock outright.
For example, we might see a bullish pattern in a stock… but because it’s too expensive, we end up moving on… only to look back at the stock a few days later and kick yourself thinking, I was going to buy that! But it was just too expensive.
Well, this is where options come into play.
Think about it like this… if you want to buy 1,000 shares of an $88 stock… it would cost you $88K… and you’ll probably think twice before putting on that bet.
With options, you can control the same amount of shares and trade it like stock, but it would cost you just fraction of that, depending on which strike price you select… and those options will move like a stock.
How does this all work?
Before we get started, there’s one thing you need to know. The moneyness of options describes where the stock price is in relation to the strike price. We’re going to be sticking will call options here.
For example, if you’re bullish on a stock, you can buy at-the-money call options. That means the strike price is very close to where the stock is currently trading. You can also buy in-the-money (ITM) call options. With ITM calls, it means the strike price is below current stock price.
Now, deep ITM call options (options in which the strike price is way below the current stock price) are more expensive than ATM and out-of-the-money (OTM) call options. You see, deep ITM options are primarily composed of intrinsic value.
With call options, you look at the stock price minus the strike price to calculate the intrinsic value. For example, let’s say a stock is trading at $90. That means the $80 strike price call options have an intrinsic value of $10 ($90 – $10).
For example, here’s a look at the options chain for Zscaler (ZS).
If you look at the left-hand side, those are key pieces of information for the call options. Now, in the middle, you’ll notice the strike price. Now, let’s take a deeper look at the options chain.
Let’s focus on the $76 strike price call options. Since the stock is trading at $88, these are considered deep ITM options, and most of the option’s value comes from the intrinsic value.
Why is this important?
The deeper you go in the money, the more the options trade like stock.
Now, there’s actually a term that professional traders use to figure out how an option will move… and it gives us an idea of whether the options trade like stock or not.
If you look at the first column on the left-hand side, you’ll notice the term “Delta”. This gives us an idea of how the option will be affected by the underlying stock price.
Now, deep ITM call options tend to have a Delta around 1.
What that means is those option contracts would trade a lot like stock. For example, if the stock moves up $1… those options would gain by $1. However, if the options moved by $0.50, those options would also change by $0.50.
Now, I actually use this to my advantage some times.
You see, if I see a bullish pattern in a stock… and it’s expensive, I have to think twice and try to figure out if the reward levels make sense. On the other hand, with options, I could actually take part in the move higher and get base hits quickly, without the need to use a whole lot of capital.
For example, I recently traded ZS based on my bullish chart pattern.
With ZS trading at $85… buying shares would’ve been too expensive and eaten up a lot of my buying power. However, with the options I bought… they were only $3.80 (or $380 per contract) a piece.
(My chart patterns are simple to follow and could provide you with consistent returns. If you want to learn more about my trading system, click here to watch my latest training session).
Now, these options were actually ATM, but the delta was around 0.68. That means the options would move $0.68 if the stock moved $1. Keep in mind, delta is not static and it will change as the stock price changes.
With the stock moving higher… I was actually able to make 15% on my money in just a few days, which was part of my plan.
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Think about it like this… if you wanted to buy 100 shares of ZS, that would cost you $8,500. On the other hand, the $85 strike price call options were $3.80. If you bought 10 options contracts it would cost you $3,800 (100 * 10 * $3.80)… and that means you would control 1,000 shares. Now, if the stock moves up $1, you make $100.
But with the options, the returns can be much higher. For example, if you bought 10 contracts, and the stock moved up by $1… those options would move around $0.68. That means you would make $680 ($0.68 * 100 * 10)… allowing you to achieve larger returns… fast.
Now, I’d love to hear your feedback on posts like these, so leave a comment below and let me know what you think.