Your Options-Trading Questions — Answered
We’re doing something a little bit different today.
I wanted to cover some of the recent questions that have come in from my Weekly Options Corner subscribers. I know the topics we’ve been covering have been very broad, and our readers have been interested in learning more.
And I think that some of these are questions that everyone has. So I want everyone to see my responses. That way everyone can learn something.
I address your questions in my video, below. And if you’d rather read my responses, simply scroll down — you’ll see edited versions of the questions and answers.
Now, last week we broke down what a profitable trade looks like. We did a case study on a trade we made on Facebook in my Quick Hit Profits service. You saw that with options, we can take a small gain in a stock and turn it into a triple-digit profit. We saw that Facebook’s stock was going to do well in its earnings season and that we could make outsized returns.
And in the coming weeks, we’ll be getting into the heart of this quarter’s earnings season. And we plan to show you exactly how we make these trades in real time. I want you alongside us when we actually see one of these trades get triggered. I want to break down everything that I’m looking at in a trade. I’ll show you why we got the price we did, why we picked the option we did and how these trades are set up.
We want you to be able to jump in and profit on your own from these trades this earning season. For that, I’ll be using my Quick Hit Profits strategy. So be on the lookout for that in the coming weeks.
But today, we wanted to do this little video mailbag. We want to cover some general questions that have been coming in lately.
So we’re going to dive right in…
Question: I missed a trade, can I still get in?
Answer: I wanted to feature this question because I get it all the time.
People will get to a trade alert and then not be able to jump in right away. And they’re worried that they’ve missed out. So they want to know if it’s too late.
Now, I love this question because nine times out of ten, it’s still going to be OK to get in.
Most of the trades I recommend do not move too fast on the first day or two. We usually time actually to get into these trades before they go above my limit price.
So that’s the key: Whenever I send a trade alert, I always tell you the highest price I want to accept. That’s my limit price. That’s the maximum that we want to pay for this trade.
There can be a lot of volatility in options prices. So we never want to chase that entry price. By sticking to our limit price, we’re able to get the best price possible. And it’s usually good for at least a few days that we can still jump into this trade.
So most of the time, no, it’s not too late. We don’t have to panic.
But if you do miss the trade, remember that we have a trade every few weeks in Quick Hit Profits. So you can hang back if you have to.
If you miss a trade one time, that’s fine. You can jump into the next trade.
Our next question comes from Doug:
Question: In general, everyone seems to always say calls are for the market going up and puts are for the market going down.
I’m thinking this isn’t exactly accurate. Shouldn’t the generalists say when buying puts, you’re ‘betting the market goes down’ instead of saying ‘put options in general are betting the market goes down’?
Answer: Doug’s exactly right here. When you talk about options in general, we always just say put options are for when the market goes down, call options are for when the market goes up.
But we’re generally speaking about buying put options and buying call options.
So when we’re selling put options, we want the market to go up. Because when we sell put options, we would be excited to end up buying shares of the stock. We just want to collect an income. And as the stock falls, once we own it, then we’re at a loss. So we are looking for the stock to hit higher.
And the same with selling call options. The risks are different because you’re betting the stock will go down or stay the same. That means if it goes up, you’ll be at a loss. This is one reason I would never recommend selling naked call options.
Though if you already own the stock, they’re great. This is a “covered” call option — as opposed to “naked,” which we talked about above. When you own the stock, you can sell a covered call and collect income. At that point, you’re either agreeing to sell your stock at the strike price for the call or you’re expecting the stock to go lower. That way, you can collect the income and then continue to sell call options over and over again.
So the general description that “calls are for when the market goes up and puts are for when the market goes down” doesn’t always apply.
That’s why we cover different options strategies here in the Weekly Options Corner. I want you to know the difference between buying options and selling options. Down the road, these strategies may become even more beneficial and help you create profits in the long run.
Question: What’s the difference between a limit order and a market order?
Answer: I mentioned earlier that whenever I send out a trade alert, I always use a good ‘til canceled limit order. That means you tell your broker the highest price you’re willing to pay for an option — and I’m talking about buying an option here. When you’re selling an option, that limit price is on the lowest price you’re willing to take for that option.
But if you were using a market order there, you would pay whatever the option was trading at that moment. It would get filled right away. That’s what a market order does: It guarantees that you’re going to get this option filled. You’re going to open it at the price the market hands it to you. And that price could be higher than you may expect.
I usually avoid those types of trades because I don’t like to chase trades. I always use limit orders. I’m going to sit at a price I choose, and I’ll sit there.
When I send out trade recommendations, I’m going to tell you to use a good ‘til canceled limit order, which means that I want to leave this on the market for up to a week before I would even consider canceling it.
And if it isn’t filled by then, I always update our readers to let them know that it’s time to cancel this order.
But nine times out of ten, we’re going to be filled over that one-week period. And it is usually filled in the first day or two.
But that’s part of being able to trade options with consistent profits: being patient.
We need to be patient with the price that we pick. Remember, this option price is going to help dictate how much profits we actually see from this trade. Whether we pay $2 or $2.50 matters. It could really alter the types of returns that we want to see.
For example, if we buy at $2, we can see a 50% gain once it hits $3. But if we rush in, if we put in the market order and we let the price run up a little bit, we could end up paying $2.50. Now, we don’t see a 50% gain until it hits $3.75. That’s a big difference.
So patience definitely pays off when it comes to trading options. So we’re going to stick with our limit prices.
Our next question is from Rob, and he asked about warning messages that are broker:
Question: I get the warning message that the limit price entered is below the market bid. Please verify the order before placing the order.
Should I change the limit price or leave it alone?
Answer: This goes hand in hand with what we just talked about, using limit orders or using a market order. And I said that limit orders are the way to go.
So in this case, you put it in that limit order. And your broker is letting you know that it’s not going to get filled to the prices above that.
And it depends on whether they’re buying or selling — the warning may be letting you know that your bid won’t be filled for a while. Either way, it’s important just to understand the dynamic with your brokers.
They’ve got all sorts of warnings that pop up. At some points, you’re just clicking the X, just trying to get rid of them. But remember, a lot of those warning signs are important.
Sometimes the warning sign is saying that the trade will take up too much of your account. Then, if you close it out, all of a sudden you have one options contract that’s taking up 90% of your account, that is something you do not want.
With options, we know that they’re extremely volatile and we’re going to see big and wild swings. So we’re going to stick to our limit orders. And that’s in either case, whether we want to sell or we’re trying to buy the option.
If you’re buying, then you want to pay the lowest price possible. If you’re selling, you want to get the highest price possible.
So keep those two things in mind when you go to place in order and be sure to read those warning signs that come up. If we’re buying an option and it says that your limit order is too low, that’s fine. If we’re selling an option and it says that your limit order is too low, just go back and make sure you’re following the right advice in my recommendation.
Question: What is margin?
Answer: It just wouldn’t be a complete options video mailbag without talking about margin. I get this question all the time. And I think the biggest thing to point out with margin is that there’s two different types of margin accounts.
When you say “margin,” it just has an overall negative sentiment to it.
You don’t want to touch margin accounts. You don’t want to mess with margin because that’s where people mess up. All you hear about are margin calls when someone is over leveraged and they can blow up their account.
But there’s a difference between a stock margin account and an options margin account. A stock market is where margin gets its bad rep from. People over leverage themselves and they end up losing a lot of money.
That’s definitely something you want to avoid. I never recommend a stock margin account where you would be trading stocks in it.
An options margin account is different. A lot of brokers require you to have this. The most common scenario is when you have an options margin account to sell put options on margin.
Now, in this case, when you sell the put option, you’re basically saying that you want to buy 100 shares of this stock per one contract, whatever stock it is. So if it’s a $50 stock, that would be $5,000 that you’d be looking to buy into this company.
But let’s say that you could do that on margin. Now, your broker doesn’t charge you anything. They just take about 20% of that as a guarantee. So instead of $5,000 for one contract, they tie up $1,000 for the duration of the option.
The premium that you collect stays the same. But that extra $4,000 can basically just stay floating around in your brokerage account. You can have it invested in any other stock and different options trades, wherever you want.
And then your broker will let you know usually in the last week that you need to come up with funds just to buy the stock. If you’re only using margin for selling put options occasionally to collect income from stocks that you really want to own, then I see nothing wrong with using a margin account, keeping the rest of the money moving in your brokerage account.
Our last question today comes from John, and he’s a big fan of Tesla:
Question: I would like to own Tesla for the long term because I believe in the company and in Elon Musk. Should I be selling puts on Tesla, thereby either profiting from the premiums or end up being assigned the stock for a reduced price?
Answer: I love this question because it’s exactly what we do in Pure Income, my put-selling research service. We just sell put options on stocks that we love to own. That’s stocks like Tesla, other giant stocks or other little-known stocks. They are interesting companies that are doing great things that we really just want to own and have exposure to.
So instead of buying them outright today, what we do is we sell put options. The whole service Pure Income is just about creating income. And we do it on great companies by selling put options.
And in this case, John’s looking to do it on his own. He loves Tesla. He’s looking at this company and he wants to know whether selling put options on the stock is a great opportunity. And as long as you have the cash to do it. Tesla is still even after the price splits. It’s a pretty expensive stock — you’re talking about a nice chunk of change here — and it’s a great strategy.
You’re just creating an income stream from a stock that you already want to own. Just make sure that you don’t go overboard, though, with the contracts because it can happen quickly… You’re trying to collect more income, more income, more income and then all of a sudden you’re going to own $50,000 of Tesla, and you have a $60,000 account. So be careful of stuff like that.
As long as you know what you’re doing, John, then I say go for it.
That’s all from us today. I want to say thanks for joining us here with the Weekly Options Corner. You can look forward, in the coming weeks, to take a deeper dove into options, concepts and hopefully …. a trade in the next week or two.
Until next time.
Chad Shoop, CMT
Editor, Quick Hit Profits