Stocks are often called the casinos of the investment world. They lack the diversification, controls, and offsetting risks that make vehicles like the mutual fund more stable in the long term. At the same time, stocks offer the potential for explosive growth if the underlying company takes off.
Just ask Bonnie Brown, the San Francisco masseuse turned Google millionaire.
Trading options based on stocks can help smooth out that curve somewhat. Instead of buying into a company you buy a contract against that stock’s performance. As with all options, you can sell the position if the underlying vehicle does well and can walk away if it underperforms.
Yet while options might not be the gamble of a pure stock transaction, there are still ways you can improve your personal odds through smart trading.
Try a covered call
Few retail investors would consider selling an option (as opposed to buying). They might want to.
When you sell an ordinary call option, you agree to acquire and sell a set stocks if they exceed a certain price. In exchange, you accept a premium payment.
A covered call is when you sell a call option against stocks that you already own. As a result, you have created a protected or “covered” position: If the stock loses, you mitigate loss with the premium. If the stock underperforms, you both get the premium and profit from the sale. If the stock meets its strike price, you get the premium and still get to sell it to the option holder for a reasonable price.
Talk about putting your thumb on the scale.
Pay attention to dividends
Dividends might slip the average investor’s notice, but they can have a big impact on option performance.
Stock prices generally fall in the wake of an “ex-dividend date.” (This is the date after which purchasers of the stock will not be included in the payout.)
So, traders who want to influence outcomes can do so with an eye to the calendar: an announced dividend will cause call prices to drop and put prices to rise as the ex-dividend date approaches.
Want better odds on a stock option? Try betting whether the stock will simply go up or down. You still have to make a call on the market, but it’s far easier than getting the exact price and date right on an option.
Which brings us to binary options. A binary option contract trades against a single question: will the stock be above a certain price on a given date? (For example, will Widget Co. be above $25 on July 1?)
Those who think the stock will do well can buy a call option. Those who think it won’t do well should buy a put. Although you still have to get the date right, in a binary option you don’t need to get the correct price, just its movement.
Don’t shop for a hot tip
When it comes to improving your odds in the stock market, there’s one important rule: be careful about hot tips.
It’s one thing to get a good idea from a publicly available source. But having a friend tip you in on his company’s upcoming merger? Learn about some new product down in development?
That’s just old fashioned trading advice.