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Know Your Options

Bullish on stocks?

Here are two ways to play it with options:

1. Buy a Call.

2. Write a Put.

How bullish you are will help determine which strategy is right for you.

1) Buy a Call

Buying Calls is one of the easiest and probably most well know option strategies.

If you believe the price of a stock will go up, you can buy a call option on it and make money as it does.

But unlike a stock, it needs to move within a certain period of time.

And based on the strike price you've got, it'll need to move a certain minimum amount to overcome your purchase price.

Knowing this, there are a few things to consider when you're selecting your option.

The first thing you'll want to consider is time.

As a rule of thumb, unless I'm speculating on a date-specific event, I'll normally buy a little extra time than I might need.

This gives me a little extra leeway and time in case the move I was looking for takes a bit longer than expected.

For example, if I'm expecting a move within two months – there's no harm in picking up an extra month or two to be on the safe side – especially if that extra month could mean the difference between a profit and a loss.

The next decision to make is if you'll pick up an in-the-money option (ITM) or an out-of-the-money option (OTM).

Just remember: an in-the-money option will have a greater likelihood of making money than an out-of-the-money option.

Why?

Because at expiration, your profit is the difference between the stock price and the strike price less your premium.

For example: let's say a stock was trading at $50 and you had two options:

• 1, $45 call (ITM) for $6.50
• and 1, $55 call (OTM) for $3.75

If at expiration, the stock was trading at $60, that's a 20% move in the stock.

At expiration, the $45 call would be worth $15 or $1,500. Remove your premium of $6.50 and that's an $850 gain.

The $55 call on the other hand would be worth only $5 or $500. Subtract your premium of $3.75, and instead you'd only have a gain of $125.

Same stock move, but vastly different profit outcomes. Sure you saved a few hundred dollars on the way in, but look what it cost you on the backend.

Of course, if you're wildly bullish, you could really get a lot of leverage on the cheaper out-of-the-money options. But usually, the out-of-the-money options are best only if you're expecting some pretty big things to happen.

For your regular moves – good moves – but not astronomical moves, consider staying closer to the money as it'll increase your chances for success.

2) Write a Put

This strategy, unlike buying calls, is probably one of the least known option strategies.

And also, probably one of my favorites.

It's a bullish strategy.

But you have more ways to profit with this one.

When Writing Puts, the stock can go up, sideways or even down (albeit only a certain amount) and you can still make all of the money you expected to make when you put the trade on in the first place.

Essentially, writing a put means you might be obligated to buy the underlying stock at a certain price if the stock goes down to your strike price. This is called 'having the stock put to you'. But you'll get paid for taking that risk.

But the benefits are great.

First, when writing a put option, I don't favor getting more time than needed. Instead, try and get only as much time as necessary to ensure a big enough premium to make the trade worth your while. This strategy will benefit from time decay.

Moreover, I recommend writing out-of-the-money options too. Not too far out, but close enough to maximize the premium you'll collect. But far enough away so your chances of keeping the entire premium remains high.

Continuing with the same example, let's say the stock was at $50 and you thought it was going to go higher or maybe even a little lower at first, but you liked the stock and were essentially bullish on it.

If you wrote a put option, let's say the $45 put for $400:

• At expiration, as long as the price of the stock was above your strike price of $45, you'd keep the entire premium you collected. (It doesn't even have to be above $50, just your strike price of $45.)

• If the stock is at or below $45, the stock will likely be put to you, meaning you'll have to buy that stock at $45. But not only did you now get to own that stock at a cheaper price ($45 rather than $50), but you also got paid $400 while you waited and got in at a lower price.

The stock would have to go below $41 to even begin losing money on the trade.

This is a great strategy if you have a neutral-to-bullish bias on a stock and would like a strategy to profit under a wide range of scenarios.

But if you're super-duper bullish on a stock, this would be the wrong strategy because you'll always be limited with what you can make.

But your chances are good that you'll get what you expected if you correctly determined what you broadly thought the stock would do (or at least wouldn’t do).

But these two strategies, buying calls or writing puts, should be considered based on how bullish you are.

Want to apply these winning option strategies and others to your trading? Then be sure to check to check out our Zacks Options Trader service.

Want more articles from this author? Scroll up to the top of this article and click the FOLLOW AUTHOR button to get an email each time a new article is published.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

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