Trading Options That Beat the Buzzer
I spent Sunday afternoon on the edge of my seat at a high school basketball game. The spread of the teams’ scores rarely varied more than five points for the entire game. In the last minute, the other team committed a foul and we were up by one with a successful free throw. Then with less than 20 seconds left the other team charged down the court and scored a three-pointer leaving us down two at the buzzer.
I’ve been thinking a lot about the buzzer when recommending option trades for Profit Catalyst Alert subscribers. Just as in that basketball game, if the score isn’t leaning in your direction when an option expires, you’ve lost your money. The flip side for an option trader is that you can close out a winning position mid-game, before expiration. It’s the equivalent of ending a basketball game when your team is ahead.
The expiration feature of options makes them one of the more exciting and frustrating trading vehicles for investors when making money comes down to the buzzer.
Options are sold with various expiration dates and strike prices. Investing Daily offers a clear and concise handbook on option trading, but they can be complicated and risky. In a nutshell, buying a put or a call option on a stock requires estimating the price the stock will be at a particular point in the future. Option expirations can be as soon as one week out or as far as two years away.
As with any forecasting, it’s always easier to predict a stock’s movement the longer the time horizon. Ask any analyst if he’d rather estimate what the price of corn or the S&P will be in one year or in two weeks. He’d likely choose the longer time frame, which allows prices to smooth out from any unexpected short term gyrations.
But time is expensive. The further out in the future that the option expires, the higher the price of the option. You can buy options on most stocks that go out at least a year. Some option series go out as much as two years. These longer-term options are called LEAPS and will put a dent in your wallet.
At Profit Catalyst Alert I usually construct my option recommendations tied to specific events. It might be an earnings report, a company meeting or even an earnings report of a customer or a competitor. If I have a firm date in hand and conviction of how a stock will move based on that event, it gives me a framework from which to choose an expiration date and strike price.
Despite the best analysis, an option trade can still go awry. Buy an option that expires too far out in the future and the stock might move too far in the future and the stock can get caught up in the tide of a fast-moving market before the event occurs. Buy an option with a near expiration and the stock just might not move in time. Option traders are constantly tiptoeing on the tightrope of price and expiration.
This earnings season has been a busy one for Profit Catalyst Alert with option recommendations.
Although not every option recommendation has been immediately profitable, I’m taking my cue from prior seasons and being patient. Last year, the majority of the option trades that I closed out were profitable despite many of them being under water at some point. Being patient was handsomely rewarded with those profitable trades gaining more than 100%.
While my team might be down a few points, I’ll be watching every pass and dribble and enjoy having some more time on the clock until those options expire.