Options Bootcamp: How to Turn Ideas Into Money

Options Bootcamp is exactly what it sounds like.

I’m designing it to be a compressed, highly effective crash course in options trading.

If you show up, pay attention, and accept that you might suffer a few bruises, you’ll come out of this a hardened option trader ready for battle.

In the past few weeks, we’ve covered some basic definitions. This week, it’s time to start applying what you’ve learned.

So today, I’m going to describe a process for picking an option trade. This is the process of turning ideas — specifically, your price targets on stocks — into profits.

For this example, we’ll use Virgin Galactic Holdings, Inc. (SPCE). But first, I want to add a disclaimer.

This is not a trade recommendation. I don’t necessarily expect the trade we discuss today to turn a profit. I am using SPCE to show how I select calls.

Now, to the process…

The first step to figuring out a call option trade is figuring out a price target. It’s essential to know this before you even start looking at the option chain.

So, let’s look at the chart to see what the price action tells us.

SPCE is more than 80% below its 2021 highs but the recent price action shows the stock could rally.

(Click here to view larger image.)

With SPCE trading at about $9.40, and the recent trading range for the stock being just under $3, I can establish a price target of $12.18. That’s if SPCE breaks out of the recent range and rallies about the same distance as the range. That kind of symmetry is typical for a range breakout.

This tells me I have a potential opportunity to trade SPCE to the upside — if I can find a call option that’s reasonably priced.

For SPCE, there are calls expiring every week through the end of April. Then there are contracts expiring in May, July, October, January 2023, and January 2024. More distant expiration dates are more expensive.

For this trade, and really any trade, we want to find the option that costs the least amount of money and matches our trading strategy.

I generally look for symmetry in price action. Since the base I highlighted in the chart formed over two months, I am looking for the price to move to the $12.18 target over about two months.

That indicates the May option could work. But I want a margin of safety, so I’ll use the July expiration just to allow a little more time for my trade to work.

Next, we need to find the right strike price…

For this trade, we’ll do that based on the profit target. I want the least expensive option that allows for a potential gain of at least 100%. The table below summarizes the available trades.

(Click here to view larger image.)

The minimum value at the target price is the difference between the target on the chart ($12.18) and the strike or exercise price of the option. When the value is negative, that means the option will expire worthless if SPCE is at $12.18 on May 20.

This value is the intrinsic value of the option, since you can obtain that price for the option even at expiration.

If SPCE rises rapidly, the option will be worth much more than its intrinsic value. That’s because the option’s price is determined by several factors.

In addition to the intrinsic value, the price of the call is affected by recent volatility, the time to expiration, and even the interest rate set by the Federal Reserve.

We don’t need to drill down into these factors today. For today, all we need to focus on is which option to trade. I would select the $10 call based on the criteria I detailed above.

The risk of this trade is $104. That’s the price to buy the call since each contract represents 100 shares.

You can see that there are cheaper options. These are cheaper because they have a lower probability of being profitable. SPCE would need to exceed our price target, or experience outsized volatility, in order for those cheaper options to return as much as the $10 call. 

There are strategies to trade these low-priced calls, but they are speculative, and most will expire worthless.

However, if SPCE rallies sharply, these options will deliver larger gains, in percentage terms, than the more expensive options.

For example, let’s say SPCE jumps to $25. The $10 call would be worth $15, a gain of 1,340%. The $14 option would be worth $11. That’s a gain of 4,131%. Those large gains are why low-priced options are so attractive.

However, those large gains are rare.

You might also see that more expensive options (like the $9 call) could have a larger percentage gain.

But I selected the $10 call based on the criteria I established to buy the least expensive call that offers a potential gain of at least 100%.

Again, this isn’t a trade recommendation on SPCE. This is simply to show you my disciplined process for turning an idea into an option trade.

I recommend a disciplined approach like this, and always use a process like this in my trading.

As you practice, follow this approach instead of the guesswork most beginner options traders rely on. You’re likely to experience far fewer losses, and will be less likely to give up on this incredibly useful trading tool.

Regards,

Amber Hestla
Senior Analyst, True Options Masters

Chart of the Day:
Another Meme Stock Bottom?

By Mike Merson, Managing Editor, True Options Masters

(Click here to view larger image.)

Speaking of meme stocks forming bottoms after six months of downtrend…

Robinhood (HOOD) investors were put through their paces since IPO. The stock is down a healthy 65%.

But, just like SPCE, it appears that HOOD has found a bottom and looks set to turn higher.               

HOOD has been in a range between about $10 and $13.50 for the past 54 days (let’s round it up to two months).

If we’re bullish on HOOD, we can use Amber’s methodology from today’s Options Bootcamp to find a price target of about $17. That represents a gain of about 30% from here.

At-the-money call options on HOOD, expiring in June, could make for a great trade here. That is, of course, if risk stays in the market and stocks keep trending higher.

Regards,

Mike Merson
Managing Editor, True Options Masters