The allure of options trading is on the rise among traders, thanks to its dynamic nature and multipurpose features. Options trading stands out due to the control and leverage it offers, and with the advancement of technology, it becomes an even more attractive means of generating income. Options are financial derivatives, which means their value is tied to an ‘underlying asset.’ This could be anything from a stock or index to a commodity. Particularly, stock options are widely traded. However, with numerous stocks available for options trading, the challenge is choosing the most suitable ones. This article aims to shed light on that very topic. Continue reading to learn more.
Selecting the Right Stocks for Options Trading
Let’s be upfront; there’s no one-size-fits-all rule here. Mastery comes with time and practice. However, you can follow some essential tips to guide your selection process when it comes to options trading.
Align Your Strategy With Your Market Insight
It’s pretty straightforward. Your fondness for a certain strategy doesn’t mean it will fit every stock at any time. If your strategy is a long straddle, for instance, you shouldn’t impulsively buy ATM Calls and Puts for just any stock. Opt for those stocks where you anticipate significant volatility spikes in the future.
Don’t Overlook the Liquidity
Prior to executing any trades, ensure that the options of the stock you’ve chosen have enough liquidity. This allows you to enter and exit trades with ease, avoiding costly slippages. Remember, the liquidity of a stock does not guarantee the liquidity of its options.
Remain Faithful to Your Watchlist
Build a watchlist of stocks you’re well-acquainted with and limit your trading to these. Better yet, focus on those stocks which have historically followed your predictions. This is particularly useful for those new to options trading.
Monitor Volatility Closely
In options trading, volatility is a key element. Be aware of the volatility levels for the stocks you trade in. Steering clear of highly volatile stocks is often a prudent choice.
Implied Volatility Shouldn’t Be Ignored
The price of options is greatly influenced by implied volatility. As IV climbs, so does the price, and it drops when IV does. Therefore, always check the implied volatility before engaging in buying or selling options. Many traders lose money on accurate price predictions by overlooking IV. Look for options with low IV to buy and high IV to sell.
Be Wary of Upcoming Events
Trading options for stocks with pending events like earnings announcements or board meetings can be tricky. Typically, IV is extremely high around these times and plummets afterwards. Coupled with significant stock price movements, this can lead to drastic changes in option prices. Hence, it’s advisable to avoid such stocks during these periods.
So, what’s the secret to picking the best stocks for options trading? Truthfully, there’s no guaranteed path to success in options trading, which can be as risky as it is rewarding. No magic formula exists—success stems from diligence, patience, and experience. Nonetheless, adhering to the discussed strategies will certainly boost your chances of triumph.