Options can facilitate the implementation of various trading strategies from complex spreads to simple sell and buys. Choosing the ideal stock to trade is critical and can be the difference between a struggling options trader and a successful one. Apart from determining the right options to trade, you must dedicate sufficient effort and time to choosing the proper stocks. Here are some tips to help you determine the right options to trade.
· Determine the Option Goal
Before embarking on options trading consider defining your goals. What do you intend to achieve from your venture? Do you want to speculate on the underlying asset’s bearish or bullish view?
Do you plan on hedging possible drawback risks on a stock from where you have a considerable position? Are you initiating a trade to generate income from selling option fees? For instance, is your strategy part of a current stock position against a covered call?
Are you selling put options on a stock you expect to own? Leveraging options for income generation is not the same as purchasing options to hedge or speculate. Your initial step should be to define the goal of the trade seeing that it lays the foundation for ensuing steps.
· Determine the Volatility
Implied volatility remains among the most crucial indicators of the option price. Research widely to understand the extent of implied volatility for your preferred options.
Compare the amount of implied volatility with the historical volatility of your preferred stock and the extent of volatility in the wider market. Doing so will be a crucial factor in determining your option strategy or trade.
Implied volatility allows traders to determine other traders’ predictions on the stock. Inflated implied volatility increased fees making option selling more attractive if a trader predicts a continued increase in volatility.
A drop in implied volatility indicates cheap option fees, which is ideal for purchasing options, especially if a trader predicts increased option value in the underlying stock.
· Determine Rewards versus Risks
Understand your reward versus risk payoff based on your risk appetite or tolerance. Suppose you are a conventional trader or investor, leveraging combative strategies like buying massive OTM (out of the money) options or selling put options may not be ideal for you.
Each option strategy comes with a clearly defined reward and risk profile which traders should understand comprehensively before trading.
· Spot Events
Events can be categorized into stock-specific and market-wide groups. Stock-specific events are things such as product launches, earnings reports, and spinoffs. Market-wide events are things that affect the broader markets like economic data announcements and Federal Reverse releases.
An event can trigger implied volatility in advance and affect the stock price after occurring. Figure out whether you want to make the most out of the volatility increase before a major event or want to wait until the dust settles down.
Spotting events that can influence the underlying asset helps you choose the most suitable expiration date and time frame for your options trading venture.
· Draw Parameters
After establishing a distinct option strategy worth implementation, you want to devise option parameters such as option deltas, strike prices, and expiry dates. For instance, you may choose to buy a long-term call at the lowest cost possible. In this case, an OTM would be applicable. If you want a high delta call then the in-the-money option would be ideal.
· Formulate a Strategy
Depending on the assessment done in previous steps, you should beware of your investment goal level of historical and implied volatility, expected reward-risk payoff, and crucial events that may influence the underlying asset.
Revising the previous steps first enables you to recognize a particular option strategy. For instance, suppose you are a conventional investor with a significant stock portfolio and expect to generate premium revenue before organizations start filing their quarterly earnings in a matter of months.
You may consider a covered call selling strategy which comprises selling calls on all or some of the stocks in your portfolio. Aggressive investors who prefer long shots and are certain that there could be a major drop in the next six months you may choose to purchase major stock indices and puts.
Before venturing in options trading research extensively, to understand what the market wants. Remember, expiry dates and strike prices may hinder a novice investor’s ability to choose a specific option. However, these tips can help you identify the right option.