Trade to Win - Proven Strategies to Make Money

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Options Strategies to Make Money 129

approved. Short positions carry unlimited risk and may not be approved

for all applicants. The level of trading that is approved depends on a num-

ber of factors, including financial strength and experience. It is possible to

trade options on futures contracts, but a futures margin account is needed

to do so.

The type of account that you have will determine the type of option

strategy that you can play. A cash account allows for trading long options

and covered calls. A margin account is required to trade short options and

uncovered or naked options. Unlike stocks, long option contracts are not

marginable.

Options are far less familiar to most traders than stocks. Therefore, be-

fore trading them, do your homework and learn the peculiar characteristics

of options and how to use them for your optimum financial advantage. As

noted above, acquiring the right to buy or sell is not free. The price of the

right is the cost of the premium. The grantor of the option receives the pre-

mium, and it is his to keep regardless of whether or not the strike price

of the option is hit. Mathematical calculations are made to determine the

value of the option and that determines the premium. The price of the op-

tion has a lot to do with the price of the underlying security, including the

following:

The current market price of the underlying security.


The strike price of the option, particularly in relation to the current

market price of the underlying security.


The cost of holding a position in the underlying security, including in-

terest and dividends.


The time until expiration together with any restrictions on when exer-

cising may occur.


An estimate of the future volatility of the underlying security’s price

over the life of the option.

The closer the strike price is to the current trading price of the under-

lying security, the higher the premium. The seller or writer of the option is

taking the risk and he will ask for a higher price because there is a greater

likelihood that the strike price will be hit. Conversely, the further the strike

price is away from the current price, the lower the premium because there

are reduced odds that the strike price will be hit and the option exercised.

For example, if IBM is trading at $109 and you want to buy a 110 call, the

premium will cost more than a $115 call because the $115 contract is more

“out of the money.” The chances of the strike price being hit are less. As

options move closer to expiration, “out of the money” calls and puts de-

crease in value. Options that are “in the money” as expiration nears will

retain their value.