Options are becoming an increasingly popular asset, mainly because of their cost-efficiency. Since the derivative gives you access to greater leverage, you can secure a position at a significantly smaller cost. For instance, if you buy shares of an $80 stock, you’d have to pay $8,000 to purchase 100 shares. If you were to buy a call option of that same stock, you’d end up only paying $2,000 to secure the same amount of shares.
So, how do you find the best options to trade? Here are six steps to guide you:
Look For the Right Strike Price
According to Money Morning, there is no one-size-fits-all rule when it comes to selecting an option based on the strike price and expiration date. There are simply too many variations for every stock that can be traded via options. Ideally, you’d want to look for a strike price that is just out of the money.
Look For Liquidity
Another characteristic of the best option trades is liquidity, or how many people buy or sell a specific contract. Liquidity means that the options contract can move consistently or substantially enough for you to profit before it expires. High liquidity also means you’ll be able to sell the contract when the time comes.
Manage Risk First
Options are commonly used to lower risk by hedging an existing position in a different financial market. But executed improperly, options trading can increase risk and amplify losses further. One of the ways to minimize risk is to use limit orders instead of market orders when buying or selling options. Limit orders allow you to get in on a position at a price you specify. Buying or selling through market order doesn’t always mean you get in or out at the initially expected price.
Keep it Simple
Adding more monitors to your setup and buying more advanced technical analysis tools doesn’t necessarily equate to higher profitability over time. For most options traders, this overcomplicated setup only adds more stress and confusion from trying to make sense of every signal that your system produces and every recommendation that a financial pundit supplies.
Stick to a Strategy
Consistency is key when it comes to trading any financial market, be it stock options or cryptocurrencies. It’s tempting to abandon a sound strategy that took time and effort to implement after only a couple of losing trades. Note that there is no holy grail system that will be accurate 100 percent of the time.
Know When to Exit
As important as it is to have an entry plan, you should also have an exit strategy. Rarely do options contracts or any asset for that matter move from one point to the next in a smooth linear fashion. It’ll be choppy in most cases, and not having an exit strategy can cause you to panic and either exit too early or too late.
The best option trades will vary based on several factors, including market environment, seasonal cycles, company-specific data points, and your personal risk management plan and investment objectives.
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