How Can I Make A Profit In Options Trading?
Everybody new to options trading wants to know how can I make a profit in option trading. For starter, we have answered this kind of question in various ways.
Options traders can make a profit in two ways, either by being an option writer or option buyer.
You can make significant profits during volatile times or when the market is less volatile or quiet. You can make a profit at both times.
Now the question is how you can make profits in less volatile times or when the market is quiet? It is because the prices of stocks, assets, and currencies are always moving, so the market conditions don’t matter. The only thing that matters a lot is the options strategy that can help you to make significant profits.
The Basics of Options Profitability
A buyer who has purchased a call option can make a profit if the stock or asset rises above the strike price before the expiry.
While a buyer of a put option can make a profit when the prices of assets fall below the strike price before expiry. You can calculate the exact profit by finding the difference between the stock price and the options strike price at the time of closing of a position.
A call option writer can make profits when the underlying asset’s price is below the strike price. A call option writer can make a profit when the stock price is below the strike price. On the other hand, a put option writer can stand profit when the option’s price is above the strike price.
The Difference between Options Buying and Writing
If the options trade works out, then an option buyer can make a significant amount of profit. The reason behind this is stock prices can significantly go ahead the strike price. While an option writer can only make a smaller return if the trade was profitable. The return of the writer is limited because of premium, so the stock movement doesn’t matter much in this case.
Challenges with Options Trading
Options trading is profitable and risky at a time. It has some challenges as well. So let’s have a look at some of the challenges with options trading.
- Options are different than stocks because options have an expiry, and you can’t hold them for an infinite period. You have limited trade duration, so if you missed that, you can’t get it back. It is because of the short life span of options.
- Due to the limited life of options, you can’t use long-term strategies, like “averaging-down.”
- The impact of margin requirements can be severe on the trading capital requirements.
- In options, multiple factors play their part in determining price move, so it is not easy to predict price direction. Factors like dividend payment, time decay, and volatility can erode the profits in the short-term.
Strategies to Make Profits in Options Trading
Look at the below-given methodologies to make profits in options trading.
It is an effective profit-making strategy and can be used in options trading as well. In this strategy, traders set a pre-determined percentage level for a specific target. The benefit of trailing stop loss is that it provides continued protection against the increasing gains, and you can close the trade when the direction is changed. For making profits in trading set stop loss, neither too small nor too large.
Experienced traders use this strategy to make profits. Once they achieve their set target, they set partial profit booking. In options trading, it has two benefits:
- It shields the trading capital up to some extent. In case of a sudden price reversal, it protects your capital from loss.
- It offers the rest position that ensures the potential for future gains.
Both these benefits can play a crucial role in options trading.
The traders book partial profits at regular intervals by looking at the time left in the options expiry. They book partial profits if the position is in profit. The biggest problem with options is time decay. Senior traders keep an eye on decaying time value. To avoid the further loss of time decay value, when they see the position is in profit, they square off the option when it moves towards expiry. If the option is in the last month, and there is no chance of valuation, then as a stop-loss measure, close the position. Time decay can destroy your profit, so you can never ignore it in options trading.
As time passes, the time decay of options erodes their valuation. When the option is in the last month of expiry, the rate of erosion will be fastest. Options sellers get higher premiums at the start because, at that time, the time decay value is high. During that time, options buyers pay the premium at the start because he is the holder of that option. For short put and short call sellers, the profit margin is limited.
Almost all the options traders trade based on technical and fundamental analysis. It allows them to gain profit even from low trading capital.
One of the worst strategies to follow in options trading is averaging-down when you are already in the loss. It sounds appealing, but as an options trader, you should avoid it. It is recommended to close your current position at a loss and begin a new one with longer expiration time. It is because the options are worthless after the expiry. Averaging-down can work well for those stocks that can be held forever, but not for the options. So, for profit-making averaging up can be a good strategy. It will work only when there is enough time left in options expiry.
Options trading is a profitable and risky game. So, you need to take every step with care and precision. You may become a millionaire, or you may end up losing all your money in options trading. It will depend on the options strategy you use for trading. So, this is how you can make profits in options trading.
Sky Hoon. Read Full Bio
Website Owner, Twitter-er
He has been trading since 2008. He started this blog to share the journey about option trading. He dabbled in stocks, bitcoin, ethereum (in Celsius Network), ETF (lazy Dollar Cost Averaging) and also built websites for fun. He used this as a platform to share my experiences and mistakes in trading, especially options which I just picked up.