What are the options basics? 1. 1 contract is the equivalent of 100 shares of the stock. 2. Buy a call when you believe price is going up and a put when price is going down. 3. All options contracts have expiration dates. 4 Strike prices: in the money, out of the money, at the money. 5. Trades are less risky when combined into a credit spread or debit spread.
What Are the Basics of Options?
- Here are the basics of options:
- Calls: you are long the stock.
- Puts: you are short the stock.
- Contracts: made up of 100 share blocks.
- Expiration: date contract expires.
- Open interest: number of open contracts.
- Volume: number of contracts traded per day.
- Strikes: strike price of options contract.
- Weekly’s: some stocks allow for weekly expiration.
- Bid/Ask: cost of contract.
I am frequently asked, “Ali, how the heck do I pick the best stocks for options trading? There’s just so many and I have no idea where to start.”
Well, you’re in luck. Keep reading for my 7 options basics filters I use to find the right options to trade.
Options have a reputation for being complicated. As a result, you need to understand the basics before delving into the more complicated options strategies.
What Is an Option?
What is an option? It gives you the right but not the obligation to buy (call) or sell (put) a stock at a certain price within a set time frame. One contract controls 100 shares.
As a result, you can trade the high cap stocks without putting up the large amount of capital needed to own 100 shares. That’s really attractive to people with small accounts.
Many times penny stocks are used to grow small accounts. However, learning options basics can give you another option besides penny stocks.
Because the penny stock sector is highly manipulated, you need a penny stock list you can trust. Options are much harder to manipulate. Because they have more moving parts than stocks, they have higher profit and loss.
The Paradox of Choice
You might have heard of a book, a favorite of mine, The Paradox of Choice? In a nutshell, when you have too many choices, you get overwhelmed.
Who the heck needs 30 different kinds of jam to choose from? Don’t get me started on milk.
Do you want lactose free? What about almond or coconut milk? I just saw oatmeal milk the other day.
Seriously, do we really need all these options?! Perhaps this is why I detest grocery shopping. Too. Many. Choices.
Enter the concept of the Paradox of Choice. Too many choices = stress. End result? You’re overwhelmed.
Options trading can be overwhelming. Check out our trading service if you want to see how we trade using options basics.
One Option Too Many?
Has this happened to you in the world of the stock market? With over 12,000 + stocks, I’d suffice to say the answer is a resounding YES.
And then what happens? You get overwhelmed and don’t even start trading. End result? No profits because you’re not even in the game.
Think about it for a minute, do you really need to look at all 12,000 stocks? No, no you don’t. So, what do you do?
The answer is, you narrow down the number of choices you have. And how do you do that? Well, you apply a filter with some great screening criteria.
Check out our real time stock alerts for entries and exits on options trades.
My Shortlist Criteria: Options Basics
Without further ado, here are my 7 filters I use to pick the right options to trade:
- LIQUIDITY. >300,000 shares traded/day
- OPEN INTEREST. >1,000
- PRICE. > $30/share
- OPTIONABLE. Options are available on the stock
- ATR. >$1
- STOCK BID/ASK. < $0.05
- HOUSEHOLD NAME
Options Basics and Liquidity >300,000
Do you want to know a quick way to find the great, tradeable stocks? The answer is, check for liquidity. As a general rule of thumb, I want to identify a stock that has an average of 300,000 shares traded per day. And, over a span of at least 60 – 90 days.
Think of trading as a two-way street; both buyers and sellers are necessary. If you’ve ever traded an illiquid option or stock, you know first-hand how tough it is to get out of the position.
Let alone at a decent price. If the stock options are like a ghost town, and there’s no buyer interest, it will be difficult to get filled.
Season traders probably learned this lesson the hard way. It’s all fine and dandy to buy a stock but when it comes time to unload it, you need someone to buy it.
You know that gut-wrenching feeling when you want/need to sell a stock and can’t get your sell order filled.
Now keep in mind this is my preference. You might like to keep the numbers higher at a million for example. If that works for you, great!
Open Interest >1,000: Options Basics
For all the underlying options, I want the strikes I am trading to have at least 1,000 contracts of open interest. This ensures the markets are liquid enough to quickly get in and out of a trade fast.
A fringe benefit of 1,000 of open interest – the bid/ask spreads are minimized, more on that below. Check out our live trading rooms to see options trading in action.
How Do You Explain Options Easily?
- Here’s how you explain options easily:
- You control shares of large companies without large capital.
- Can profit long, short, or when market trades sideways.
- Exercise the contract and own shares or trade the contract.
- Great way to leverage and profit or hedge against existing positions.
Price > $30.00: Options Basics
I like cutting out the penny and lower-priced stocks, so, I set my filter for stocks > $30.00. Don’t get me wrong, there’s nothing wrong with penny stocks or those under $30.
Heck, I trade them myself. But my criteria are a bit more strict for options as I’m holding on to them longer than a day.
I am looking for a good range of movement from the stock, which can have an impact on the option I would be using to trade the underlying stock with.
My own experience with the lower dollar stocks is that while they do move and you can profit, it’s hard to catch them. A $2 move on a $10 stock is a large 20% move.
These epic moves happen every day, but you need to find them. This can be tough if you don’t have the right software and hardware.
An option by comparison just doesn’t see the same oomph, and that’s ok. Besides, I can find this same $2 move on a $50 stock.
Even though it’s only a 2% move, it happens every single day and I can capitalize on it. Take our advanced options strategies course to learn more about how to minimize risk.
This is the most obvious thing to look for when filtering the best stocks for options trading. Firstly, the stock you want to trade options on, need to have options available.
Completing this step will save you a lot of time and frustration. There’s nothing worse than spending all your time searching, finding the perfect stock, analyzing it only to find out you can’t trade options on it. Been there, done that, got the shirt.
Adding the Average True Range Filter greater than $1 ensures I buy an option that, historically, moves. This filter defaults to a 14-period setting or longer and smooths over a 100-period setting.
What’s great about this filter is it will trim off the stocks that do not really move intraday much.
I like the longer 100-period ATR setting because it gives me a nice list of stocks that tend to move and oscillate on a day to day basis.
Stock Bid/Ask Spread Is Less Than $0.05
This is the difference in price between what the buyers and sellers are offering on a stock. As with day trading, the closer the bid/ask spread, the more efficient a marketplace for that stock.
What’s more, this translates into stock options too. Keep in mind $0.05 is my personal choice, and quite frankly, it helps to filter out those stocks with a monster spread.
What I tend to see with stocks with large spreads, they jump around, a lot. And this is not what I want when trading.
The Household Name: Options Basics
This is totally up to you but personally, I like to trade the names I’m familiar with like Apple (AAPL), Facebook (FB) and Netflix (NFLX).
These guys are the heavy hitters and when they move, they move big. With these options, you can hit home runs if your analysis is sound.
Final Thoughts: Options Basics
When I use these 7 steps, my list is whittled down to about 400 stocks. Not too shabby considering we started at 12,000.
So, there you have it, my criteria for finding the best stocks for options trading. If you think options trading might be for you, check out all our great selection of videos and blogs.