If you’re wanting to increase your income by investing in options, it’s important to familiarize yourself with the ins and outs of options. You might know that stocks give you ownership share in a company, but what about options? These give you the right to buy or sell shares of stocks for a specific price in the future. You can also hold on to a stock for as long as you want, while options expire eventually. The following are just a few ways you can increase your monthly cash flow using options trading.
Benefits of Investing in Options
When you work with options, the contract covers 100 shares of an underlying stock. It comes with a strike price as well as an expiration month. If you’re the buyer of a call option, you have a right to purchase the stock at the strike price before expiration, and the seller is obligated to sell you the shares at that price. The amount that you pay to the seller is called the premium.
Some investors believe that options trading is riskier than investing with stocks, but that’s not necessarily accurate. Options can end up reducing risk since you’re not owning the underlying stock. So if the stock’s price dips, your loss isn’t as extreme. You also only end up losing at maximum the premium that you paid for the option. As an added benefit, you have potentially unlimited profit capabilities.
Use the Greeks
Numerous factors can affect the price of options, and experienced traders refer to them as the Greeks, since they are associated with Greek symbols. These risk measures are represented by the following:
- Delta: This measures the change found in an option’s price over time. Think of it as the speed at which the price changes.
- Gamma: Gamma options measure the rate of delta over time. Think of it as delta’s acceleration.
- Theta: This factor measures the price decrease over time.
- Vega: Vega determines the risk in implied volatility in regard to the underlying asset’s price.
- Rho: This simulates the effect that interest rates have on options.
These numbers change over time, depending on which options and timeframe you examine. Many expert traders calculate these values daily to determine if they need to make any changes to their strategy.
The option’s price always has a time premium, which is determined based on the time to expiration, proximity to strike price, and the share’s volatility. The options with the highest time premiums have strike prices closest to the share prices. Longer expirations typically have lower time values. For instance, if an option has six months until expiration, it most likely has a higher price compared to one that expires in just three months.
Options trading can be an exciting and profitable endeavor if you do your due diligence and incorporate risk management practices. As an extension of stocks, options can work for you to enhance your portfolio. Even if you have limited financial reserves to work with, investing in options can be a beneficial way to get started in the world of trading.