BlackHat Money

There is an abundance of money that can be made in the stock market. But not everyone will be savvy enough to get money out from there. It is difficult to calculate the ratio but some people has gained a lot from stock market trading but quite a few has lost a lot as well.  It is quite indecisive. There are times when you have lost money at a certain moment but a few days hence the trend has reversed and you ended up with a profit. The main question now is how do we get the money out from the stock market? Generally, the difference between trading and investing is that with trading, buying and selling of shares, futures or options within a short period of time is involved. Investing is buying shares, futures or options and holding onto it for a longer period of time, usually about a year or so before selling it.

Now we ask, what is the difference between a share, future and an option? To the best of our knowledge, an option is much cheaper than a share or a future. In short, should you have a certain amount of money that can buy you 100 units of share, that same amount money can be used to buy 1000 unit of option. Both share and option has practically the same return on investments. It then follows that you will earn about ten times more if you buy option instead of share or future. The downside is, when you are trading options, you can lose about ten times as well. The upside is, when we trade option, the amount of money that we can make or lose is almost the same as when we trade share.  Still, a lot more money is needed to buying a share as compared to buying an option.   To further elaborate, when you buy one unit of option for $1, you will need $10 to buy one unit of share. When the price of share drops by $.10 which is equivalent to .01%, this translates to a 1% drop in the price of option. This is why the percentage for profit and loss in buying option is much higher compared to buying shares. The impact of a small fluctuation in the price of share is magnified by ten times when you buy option as per our example above.

Buying option, trading or investing in option is rather similar to gambling because of the extra high profit or loss involved.  Yet, it is also rather normal that you can loose all your money in any investment or trading.  For you to earn more rather than loose, some basic option trading strategy and technical analysis should be learned. Option is a different animal than a share.  Option has time value but share do not.  In the passage of time, the value of one share will not depreciate.  Aside from the performance of the company, it is only impacted by the supply and demand for it. On the other hand, option can depreciate in relation to time.  Upon the passing of the option’s expiration date, the time value of the option is lost.  This is why a strategy is indispensable when trading option so that you can avoid if not minimize the loss and maximize the profit.

The two most basic strategies in option trading are bullish call spread and bearish put spread.  Bullish call spread is simply used when the stock price is expected to be in an upward trend in the next few months. Bearish put spread is used when the stock price is expected to drop in the next few months.  The steps involved in this strategy are buying in the money option and selling out of the money option.  In the money option has time value as well as intrinsic or actual value while out of the money option has time value only.  Upon movement of the stock price to the positive side, also known as ‘generated money side’, in the money option shall generate profit and the out of the money option shall generate losses. When you deduct the loss from the profit, the result is the net profit generated from the strategy.  When the stock price moves over to the out of the money stock price, the profit will be maximized because constant movement of the stock price to the positive side will not generate any profit. When this situation is reached, we will close both positions to take the profit out of the market.

When the stock price moves to the negative side (opposite side that causes losses), the value of in the money option will be less while out of the money option will generate profit.  But, the profit made from out of the money option will be limited to the selling price.  Once more, take the profit from out of the money and deduct the loss from in the money option; this will have a negative value. This is because the profit from the out of money option is less than the loss from in the money option. In this strategy, the profit from out of money option is limited and in the money option is unlimited.  Should the stock price continuously move to the negative side, your capital maybe totally diminished.  Now, what is the difference between buying naked option and buying option using spread strategy?  Mainly, the difference is that you can lose money should you buy naked option and lose lesser money should you opt for spread.  The reason is you don’t make any profit when you only buy naked option; while profit is made from the out of money option if the stock price moves to the negative side. The drawback of the spread is that the commission charged by the broker firm is twice compared to the naked option. This is due to the spread having involved two positions while naked option involves only one position. Each position will have a commission charged from it (separate commissions).

After all, the objective of selling out of money option in the spread strategy is to minimize the loss of the time value of in the money option. In reality, the time value of both in and out of the money option would depreciate when time has elapsed. Since we do not own the out of money option; we therefore can keep the money that we get from selling that option. Upon the depreciation of the time value of out of the money option, we can use the lower price to buy back the option. Therefore, we sell at a high price and then buy back at a low price; this is when we have earned some money. Usually, the money that we earned would be enough to cover the loss of the time value from in the money option. Although, you still stand to lose the intrinsic or actual value of the option if the price of the stock moves in the negative direction.

Finally, bullish call and bearish put spreads are two of the very basic option in trading strategies. Be aware though that they are not 100% guaranteed to win in the stock market. What is still needed is to learn how to predict the stock price direction accurately with the use of technical, fundamental and news analysis or just plain stock market tips.