How well do you know your options? Yes, you heard me correctly. How well do you know your options? Do you know what options are? Are you familiar with them in the stock market, how options work?
Welcome to The Stock Market Millionaire, episode number three, which is called, “Getting Started with Trading Options.”
Now, if I go to a party or any environment where someone might not know me, and you’re kind of introducing yourself and getting to know the people there, and someone asks, “what do you do for a living?” Well, my immediate answer is, “I trade the stock market.” And, there’s a lot of intrigued, there’s a lot of interest. For some people you’ve got be careful; they’ll kind of back into the corner and not let you go. I’ve got family members like that that always want to know about stocks to trade, and kind of push you back into a corner. And I let them know that, you know, for me, they asked me, “what kind of stocks do you trade? What are the stocks that you like to trade?” And my answer is, “I don’t really trade a lot of stocks,” and that’s a little intriguing for them again.
So they said, “well, Rob, what do you trade?” “Well, I trade stock options.” “Okay, okay, okay. What the heck is an option?” What’s a stock option?
Well, an option is a vehicle that you control the stock, but you don’t own it. And, I really do believe that the best way to explain this is to use an example, and the example that I want to go through and use with you is one that many of you will be familiar with – it’s about a house, right?
Let’s say you’re driving down the street. It’s just you. Your significant other is not with you. You driving down the street – you guys have talked about buying a house before – and all of a sudden, you see this house, you slam on your brakes from 50 feet away. You say, “that is the house!” You jump out of the car, you get, you see the front of the house. You kind of walk around without stepping on the property, just to see how much of the back you could see the yard, the side and so forth. You love what you see. You ring the doorbell. “Hey, I saw you a for sale by owner sign. I’m very interested in your home. Can I take a look?”
“Absolutely. Come on in.”
You come in the house, you look around and you go, “my goodness, this is awesome. I love what I’m seeing in here. I’d like to make an offer on the house.”
Now, here’s the thing. The owner wants $400,000 for the home. You know you don’t have the $400,000. We’ll wait. Don’t you need to check with your spouse. No, no, no, no. This house is so good, your significant other is going to say “yes” as soon as they see it, they want this one more than you do.
“Mr. And Mrs. Owner, I don’t have the $400,000 today, but I think I can get it. So here’s what I’d like you to do. I would like you to take your home off of the market for the next 30 days.”
“Why would I do that for you?”
“Well, I’m going to pay you. You’re asking $400,000 for the house. What if I were to give you $5,000, you take the home off in the market and agree to sell it to me within the next 30 days for $400,000, plus the $5,000 I already paid you. The five is not a down payment. That’s for our contract that we’re entering into on this option on this house.”
So let’s back up a second. What does that contract to do?
That contract gives me the right, but not the obligation to buy or sell the house at a set price, $400,000, on or before a set date, 30 days from now, and for that right, it costs me $5,000.
Well, Rob, that sounds like it could be a really good deal. It absolutely is. For me as the buyer, you, as the buyer, if you don’t have that $400,000, it gives you the opportunity to come up with the $400,000.
You go home. You tell your significant other. They are as static. They’re so excited. They love it. You show them all the pictures, you took the video on your cell phone, they are stoked.
This weekend, the newspaper comes out. You pop open the paper and you see right in the paper, in the local section, they are talking about the area that you’re buying a house in, and it says, and I quote that they are putting a state prison right behind your home. Property values expected to drop 25% overnight.
Well, you never bought the house. You have the right, not the obligation. The owner of the house cannot force you to buy it. You’ve got the right to do so, but do I really want to buy a house for $400,000? that’s now worth $300,000? Of course the answer is no.
Your choices at that point are, I’m going to just give up and not even try to come up with the cash, or what? Buy the house, which I’m not going to do! So my only choices you can keep the $5,000. I don’t like losing or spending that five grand, but what if I bought the house? What if I spent 400 grand? I’m out a hundred thousand dollars overnight.
You see, when you went ahead and entered into that contract, you had the right, but not the obligation to buy the house. Oh, I get it! On or before a set date (30 days from now) at a set price ($400,000) plus the $5,000 you’ve already paid. Let’s say that you’re depressed at this point. You’re, you’re disappointed. Not depressed, but disappointed.
Let’s say that next week, you’re reading the same newspaper, and it says, “CORRECTION,” last week, the story about a state prison. No, no, no, no, that’s going in the town over from where you were. The town where you are got a new contract with a golf course company, and they’re building an 18 hole golf course right behind your home! You’re so excited. You get online. You look at the aerial map and you see right behind your house, maybe 50 yards back, is the ninth hole. You’re so excited. Property values expected to soar 50% overnight!
Well, wait a second. If you are the owner of the house, would you want to back out of that deal? You would want to back out of the deal if you owned it. How about the person that entered the deal said, “I want to buy it, I have the right to buy it. I would like to consider buying it.”
Do you want it back out? No, no. I don’t want to back out. Well, the owner can’t back out. You have the right, but not the obligation. The owner has an obligation. They’re obligated to sell you the house at $400,000. If you turn around, you already paid them five, you pay them another $400,000. You spent $405,000.
You now sell the house at $600,000. You made $195,000 profit.
Now, remember you had the right, but not the obligation to buy the home at a set price, on or before a set date. And there was a fee for that $5,000. Well, that ladies and gentlemen is what an option on a stock is. I have the right, but not the obligation to buy the stock at a set price, on or before a specific date. And for that right, I pay X for that position, whatever X is. We’ll talk more in future episodes about the various types of options, how they work, how the pricing model works and all of that. We’ll get into all the details of that. But for now, once I explain what the option is, people say, “ah, I got it. So then Rob, what are the best stocks for options trading?” And that kind of giggling because everybody’s looking for the best, the biggest, the brightest, the best! It doesn’t quite work that way.
There are not the best stocks for options trading. If I were to answer that question, here’s the best stock: AMZN. It’s a $3000-stock as of this recording and has very, very expensive options for most people. But I love it. I love to trade it all the time. That doesn’t make it the best because I like it. It’s the best for me maybe, or one of the best for me, but that doesn’t mean it’s the best.
But we talk about the best stocks for trading options, and I’ve only just some that everybody can, can understand and relate to. You find companies that you like, you know, like, and use. Really that’s it.
Who do you know, like in use when I was younger, where did we take the kids? We have two girls. Right? We took them to Disney. Right? So I’d be looking at Disney stock, right? Oh, we bought them Nike shoes or we took them to McDonald’s. I know, I know it’s not good for you, but we took them anyway. Right. We didn’t know it. Wasn’t good for you. They lied!
So you find companies that, you know, like in use and you trade those types of companies.
“Okay. Well, Rob, when, when you look to trade them, how do you do it? How do you trade options on them?”
And again, just like that contract, you could buy an option, let’s say a call option, and there are two different types of options – calls and puts – and there definitely will be individual trainings on each of those that I will do. But, let me explain to you what an option is based on a call or put, because it was hard for me as a brand new trader to remember.
One is when it goes up, one is when it goes down.
One of the options increases in value in the stock market goes up (calls). The other one increases in value in the stock market goes down (puts). Don’t try to wrap your head too heavily around this just yet. You’ll have a better feel for it when we get into our other trainings on the individual types of options – the calls and the puts.
But I needed a way to remember it. And if you can remember this simple little thing that you do every day, I would say almost guarantee every day of your life, then you will be fine. When I was in high school. Now I’m from the age of, there were no cell phones, there were no answering machines. Your phone was on a cord. We had the 25 foot cord, right? This ugly green phone hanging on the wall with this cord, right? And you could walk into the bathroom and closed the bathroom door to get some privacy. There was no walking away. But there was this girl, Mary that I really, really, really liked in high school, and I wanted to ask her, but I was afraid. And my friends kept pushing and pushing. “Do it, man, call her, call her! Ask her out, ask her out!” I finally got the nerve one night. I dialed the phone and my friends are standing there as it’s ringing. And as they’re standing there, right, the phone gets answered. So, what did I have to do to make this call? I picked up the phone to place a call.
So, when you buy a call option, you want the stock to go up with a call. You want the stock to go up.
So I’m on the phone now, and Mary answers, I recognize her voice. My heart is pounding. And I said, “Hello, and it’s Rob.” And all of a sudden, she hung up. True story! So I looked at the phone and I was done now so I put the phone down.
When you buy a put option, you want the stock to go.
Now again, don’t try to wrap your head around too much of it. Just get really good at understanding. Call up, put down for some of you, I promise you this would be your next week. You’ll be looking around, see if anybody’s watching you and do it yourself!
Got it. And if you think it’s a silly method, that’s fine. I needed this to help me remember it. If it helps you awesome. If it doesn’t awesome, right? It works for me. That was the important thing.
So to trade them, you trade them directionally. If you think the stock is going up, you trade a call. If you think the stock is going down, you trade a put. But you really need to make sure that you understand the top option trading strategies. There are ways to trade them properly, and to properly have puts in calls, explained to you or to explain them to somebody else, you’ve got to have some knowledge, some understanding of how they work. And that was the idea of what we’re doing here is to give you that base knowledge, that base understanding of what options are and how they work.
For right now, if you can remember an option gives you the rights, but not the obligation to buy or sell a stock – depends which side of the market you’re on – at a set price, on or before a set date.
That’s the key. And remember, I place a call. The phone comes up when I buy a call and I want the stock to go up. When I buy a put, I want the stock to go down.
I know some of you that are younger than I look at me saying, what does this mean? That was the shape of a phone, right? Not these that out there. These.
So there you have it, ladies and gentlemen, I hope this was helpful for you. Now. Remember stay focused on the quest of becoming a great trader, keep crushing it and always remember folks. You’re just one trade away. I will see all of you at our next episode. Take care for now, bye