Limit orders are a way of setting the maximum price you are willing to pay. If the option is infrequently traded, it will often have a wide spread (the distance in price between what someone will pay to purchase the option versus what someone is willing to sell the option for). As a result, you risk overpaying.
With that in mind, Jeff has carefully calculated the maximum you should pay for an option, compared to how far he expects the stock to move. Remember, his goal is to hit a triple-digit gain on the position. By setting a limit order, we ensure you pay a fair price for the option without undercutting your ability to hit that triple-digit win.
If the options market price is above Jeffs recommended limit price, you should not purchase the option. Otherwise youre chasing the trade, and thats something we dont want you to do.
Lets look at a quick example:
Say we decide to trade a December $80 call option at Jeffs recommended limit order of $3.50. To get a 100% gain, the underlying stock would need to rally 8.8% to $87 ($3.50 x 2 + 80) so that the call will be worth $7.
Now, what if you chase the trade and pay $4.50 to buy the options instead? You need the stock to rally to $89 ($4.50 x 2 + 80) for the option to reach a value of $9, for a 100% gain on the position. In other words, the stock has to rally 11.3% for you to get a triple-digit gain.
Set the limit order. If it comes back down to our price, great. If not, we move on to the next trade. And dont worry; youll have plenty more opportunities to make big gains.
If you havent seen it yet, Jeff created a great video that walks you through placing an options trade with a broker. Click here to watch the video, How to Place an Options Trade.