Not many financial traders know much about index option trading. But it’s possible to make regular large profits with minimal risk with this method.
Most of us know about options. Instead of buying actual shares, you buy the option, or right, to buy them at a later date, e.g. 3 months ahead, at a price similar or identical to their current price.
So if you consider the stock of XYZ Inc, current price $10.00, is about to rise, then you could buy an option to purchase, say, 1,000 shares at $10.00 each in, say, 3 months’ time. The cost (or premium) of the option might be 10 cents a share, total $100 (1,000 x $0.10).
In addition, your risk is less, because the most you can lose is your premium of $100, if the price does not rise. If you bought the actual shares your theoretical risk would be $10,000, though only if the company was to go bankrupt and the shares become worthless. In spite of this, options are an excellent alternative to shares, and you can have an interest in many more shares for your money, which brings us to the next point.
If the share price rises as you predicted, then you can make a massive profit. In this example, if the share price rose just a little to $12 from $10 within the three months, which is quite feasible, then you would be able to sell your option for $2,000, i.e. you’d in effect buy the shares for $10 each, total $10,000, and sell them for $12 each, total $12,000. The profit is therefore $2,000, less the original $100 premium, giving a net profit of $1,900.
If it’s as easy as that, then why would anyone sell an option to you? Because they might be of the view that the shares will probably go down in value.
Now we come to index option trading. The trouble with the example I’ve just given is that it can be very difficult to predict future price movements of individual stocks unless you are very familiar with what’s going on in that company. But you can easily do this with an index of a number of companies in a particular category.
Suppose you are keeping close track of what is going on in the utilities sector. If you find a suitable index of the companies in that sector, you can track it, and when you consider a move upwards in price is due then purchase the index option. Or sell it if you think the price is about to go down. The advantage here is that any individual share volatility will be ironed out and you will be protected against unexpected price moves.
Of all the stock trading tools you may find, this must be one of the best. If you keep yourself well-informed in a few sectors as I’ve explained, something that’s not too difficult to do, then you should be successful far more often than not, and given the risk/reward ratio explained above you should be able to make regular profits with minimal risk.
Philip Gegan
