How to Enter An Option Play

Option Plays can be very profitable, if done correctly.  So what are the steps to enter an option trade successfully?

1.       Find A Trade

The first thing you need to do is find a stock that you believe will make a big move in a short time period.  This stock may be bouncing off of support, breaking through resistance, or giving you whatever you consider to be your buy signal.

If the trade looks like it could be a great stock trade it may also be a great option trade.

2.       Look at the Options

You want to make sure that the stock actually has options available before you can trade the options on it.  You also want to make sure there is not a wide gap between what you can buy them for and what you can sell them for.

If the gap is too big it might not be worth entering the position because of the extra risk involved.

3.       Determine your Risk to Reward

You are going to want to determine how much you would risk if you were wrong and how much you can make if you are right.   To do this you can determine the difference between the price you believe the stock will go and the strike price of your option.

So if the stock is trading at $87 and you bought the $80 option it would be worth at least $7.  If you paid $4 for the option, that would be a profit of at least $3.  

This can be useful to help plan your exit and decide if the trade is even worth doing at all.

4.       Determine how much to risk

When trading an option you should always assume you will lose all of it.  So, plan accordingly.  Any option contract you trade should only be a small amount of your total portfolio.

5.       Enter the Option

If the stock follows all of your rules and has a great risk to reward ratio you can enter the option and follow your exit plan.

For more on stock options visit http://www.stocks-simplified.com/stock_options.html