I’m guessing you didn’t win the $1.1 billion lottery either?
I almost never buy lottery tickets. But while I was picking up a few things at the convenience store, that 10-figure number was staring me in the face and I indulged. Even though I have nothing to complain about when it comes to finances, $1.1 billion would certainly move the needle.
After all, it’s fun taking a little bit of money and trying to turn it into a lot of money.
I remember when I was first learning about investing and a friend told me about options. Now, this friend always had some scheme cooking, so I was pretty hesitant to believe him when he told me how I could turn just a couple of hundred dollars (or less) into thousands of dollars.
So I dug into it and learned everything I could about options. So much so that years later, I was hired by market makers of the Pacific Exchange to lead an options conference in San Francisco.
Turns out my friend was right. You can turn a very small amount of money in options into a lot of money if you make the right trade.
That’s not the only way to trade, though. There are many ways to make money with options. Some are more speculative than others. Some make a little bit of money, and some can generate large amounts of profits.
First, let’s talk about what an option actually is.
An option is a contract that gives the buyer the right but not the obligation to buy or sell a stock at a certain price by a specific date.
A call option gives the buyer the ability to buy the stock at a certain price (the strike price) by a certain date (the expiration date). A put option gives the buyer the ability to sell the stock.
Let’s take a look at both the buyer and seller of an option.
Conservative investors like to sell options. As the seller, you generate income. It’s for investors who are happy hitting lots of singles rather than swinging for home runs.
For example, to place covered calls, investors buy a stock and then sell a call with a strike price usually a little bit higher. An investor could buy 100 shares of Apple (Nasdaq: AAPL) at $135 and sell the February $140 calls for $3. That means the buyer of those calls will pay $3 per share, or $300 total (because options contracts are in 100-share increments). If the stock is above $140 by February 17 (the expiration date), the buyer can force the seller of the calls to sell their shares at $140, no matter the price of the stock.
If Apple is trading below $140, the calls will expire worthless and the seller will keep the money. The seller will make an easy $300 and hold on to their stock.
However, the buyer of the calls will have an instant profit if the stock is above $143 ($140 for the stock plus $3 for the calls). If the stock is trading at $150, the buyer will have a gain of at least $7, more than doubling their money in a month. The higher the stock goes, the larger the gain.
The buyer doesn’t have to wait until the option expires to collect a gain. If the stock rises in price, the option price will increase as well. So if in two weeks the stock is trading at $150, the option they bought for $3 may be worth $11, more than tripling the buyer’s money.
If Apple’s stock does not rise above $140 and the buyer waits until expiration, the option will expire worthless, as I said earlier, and the buyer will lose the entire $300. But just as when the stock was going up, they don’t have to wait until the option’s expiration to exit the position.
If the buyer is no longer confident that Apple will rise, they can sell their call option well before it expires and collect some of the money back that was paid.
I’ll never forget my first big options trade about 20 years ago. I bought $500 worth of calls in a company called Sun Microsystems. The next day, the company reported stronger-than-expected earnings and my $500 turned into $5,000.
Of course, they don’t all work out that way, but it takes only a few of them to add some real money to your account. And you can swing for the fences for just a few hundred dollars, or even less, per trade.