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Hey, there. Ross Givens here at Traders Agency and say we’re going to talk about stocks versus options, specifically when you want to own the stock and when you want to own the options.
Now, first of all, let me apologize. I’m soaking wet. It is pouring rain here, but I wanted to get this down because I’ve been getting a lot of emails and a lot of questions asking specifically about options when to trade them, how to trade them, and when to avoid them. These are great questions because when it comes to your money, there’s no such thing as a dumb question, and there are dumb times to own options. It could cost you a lot of money. Let’s dive right in.
I want to look at two stocks and compare and contrast the times when you want to own an option and times you want to own a stock. Let’s start with stocks because I am primarily a stock trader. When do you want to own the stock? Not the option. First of all, any time you were holding it or investing for the long term, I mean, anytime over probably six months, own the stock, not the option. Period. You’re going to pay way too much for the options.
Options have something known as intrinsic value. Meaning, you’re paying for the opportunity to see what that stock does. You’re paying for the exposure until that option expires. The odd that a stock goes up 10% in the next six months, pretty good. Three months out, a little less. A month out, definitely less. A week out, very, very low. As you go from having six months at options expires to a month till expire to a week to a day, if the stock is not going up, the value that option is going to decline because the chances of that strike price being hit are diminishing. It’s a concept known as time decay. All it means that the value of an option, LLS being equal, the stock goes nowhere, that option is going to go down and values that approaches that expiration date. When you’re going out a very long time, you got a lot of option decay to fight against. You’re paying a lot of money for the option. It’s just not worth it. Trust me. Own the stock.
Second is both low priced and low valued stocks and companies. For example, if you’ve got a stock, it’s maybe $3, $4. Generally, you don’t want to own the options, the spreads to wise percentage of the price. If it even has options, you’re generally better owning the stock. Now, if you’re looking at, say, an Amazon, that’s 3,500 bucks a share, and you only want to invest a thousand or 5,000 or something that comes out to half a share or two shares or something. Yeah, options are much more appealing, and I understand that. On a lower price doc, you don’t have that same problem.
Also, in very small companies, not do a lot of small to mid-cap companies. When it comes to capitalization, it just means the value of the company, what it would cost to buy every single share, right? Apple is worth over a trillion dollars, whereas some companies are only worth a $100, $200 million. There are small and micro-cap stocks. These smaller stocks awfully have lower volume, less people are trading. And because of that, a lot of them don’t have options. They haven’t been created by the CBOE. Options often are not even an investment option for you. No pun intended for a very small company.
Then some do have options, but there’s so thinly traded with such widespread. Doesn’t make sense. For example, I can’t tell you, I mean, dozens and dozens of stocks, I’ve recommended my Insider Edge product, where I go to find an option and you’ve got an option three months out near the money, and the spread…When I say spread, I mean, the bid versus ask the bid.
What people are willing to pay for, say, a $1.25 per share. The offer, we’ll do a sell for $3.25 per share. If you hit market order, you’re filled at 3.25, you go to sale, it’s on the worth of buck 25, so you’ve lost 60% before you even got out of the shoot. The spreads out wide, it really doesn’t make sense. It’s just not a tradable market. You definitely want to stick with the stock in that situation. All right.
When do you want to trade options? Well, as I mentioned, higher price stocks can be a good opportunity to buy options because it wouldn’t create is a limited risk situation in terms of dollars. You hear a lot of options and say, “Oh, they’re riskier. They’re more volatile.” That’s true on a percentage basis, but not always true on a dollar basis. This is a big mistake. It’s been a lot of people miss. A lot of folks, let’s say, you are going to buy a $10 stock. You’re going to buy a 100 shares of it, so a 100 times 10, a $1,000 invested. All right. That’s your total capital at risk. How much could you lose? Well, a $1,000 dollars, right? If the stock goes to zero, it’s gone.
However, if you bought a call option, let’s say you bought a $10 option that expires and let’s say three months. What that gives you is the right to buy that stock for 10 bucks at any time for the next three months. Basically, if the stock price goes above 10 bucks, all that’s your profit on a 100 shares, that might cost you somewhere in neighborhood of — I don’t know — maybe 80 cents to 1. I’ll call it $1 per share. You buy these options. Same situation. Stock goes to zero. How much did you lose? You lost a 100 bucks. You lost $1 per share times a 100 shares instead of a $1,000, but you still have all the upside. That stock went from $10 to $20. The profit would be the same. You’re still going to make a $1,000 profit, whether you own the stock or the option, as long as it happens in that window when your option expires.
That’s one thing. The mistake people make in this situation…For example, we had a $1,000 stock trade or $100 option trades, same exposure for the three months, same profit, if it goes up, but less risk on the downside, but here’s the mistake they make. They go, “All right, I was going to buy a $1,000 with the stock. I’m just going to buy a $1,000 worth this option.” There’s your mistake. Why? Because if this stock goes nowhere, if it just stays or let’s say it only goes up a little bit, or it goes down maybe five or six percent, that option’s going to zero in three months.
On a percentage basis, you were going to lose or make more that option. If the stock goes down, you’ll lose a 100 percent of that option. Whereas you would lose me 5% on the stock. You see? The way to position this is take the amount you were going to risk on the stock and put that into the call option. If you’re going to buy the stock at 10 with a stop at 8, meaning you would sell it if it goes 8 bucks, you are going to risk $2 per share. You’re going to risk 200 bucks. If you bought $200 worth of options, that now creates the same risk reward stretch, okay? That’s where people screw up. Percentage wise, yes, the risk is higher, but you don’t need as many dollars invested. This is a big benefit for small account traders as well because if you only want to put a couple 100 bucks per trade, call options or put options is really the only place you can be able to allocate your dollars in those size of mounts.
Now another concept you need to know what the options are. I don’t want to get too deep into the Vegas and the deltas and all this crap, but you need to understand one thing, and that is the concept of implied volatility is. It’s crucial if you’re ever going to buy an option. I’ll show you what it means. Let’s take the chart of Netflix here. This is an option chain for Netflix. Now, I’ve never seen an opportunity pretty straight forward. It’s going to have the expiration. Here’s the strike price. This is the volume, open, enter. You don’t need all that. All the matters is the bid-ask prices. Okay.
For example, Netflix currently trading 585. Let’s say you didn’t want to buy the shares. They’re very expensive. You bought some call options and we’ll go out 30 days. We’ll go out to 90 days. Excuse me. We’ll go out to December. You see 92 days to expiration. The number we should have focused on, over here on the right side, you see this right here, I’ll hover over it, it says implied volatility. It’s Britain as a percentage. The higher that number, the more volatile the stock is and the larger move the market is expecting.
You see in parentheses, there’s a plus or minus. For example, these December of the next 92 days, the market is expecting Netflix to go up or down by $77.5. That’s a total range they’re expecting. Implied volatility around 32% is not that high. Generally, anything under about 40% to me is acceptable. When you get into a really volatile stock, let’s say a stock went from 10 to 50, to 30, to 5, to 80, the IV is going to be very, very high because the stocks moving a lot.You’re going to pay more for that exposure because the stocks can make very large moves.
Let’s contrast that with another stock. Let’s look at this one. IRNT. It says IronNet. I look at this stock. This thing went from 10 bucks to 30 back to 15, cut in half. And then all the way back up here to the 40, that’s a lot of volatility. It’s a much a higher volatility stock, right? Let’s look at what those options are. All right. Now, remember, Netflix implied volatility of December is around 32%. There’s some bigger numbers, that 400, 300, 200. This is sky high implied volatility. All right. What happens there is that you’re paying a lot more because the stock can make a larger move, right? What are the odds that Walmart is going to go up 20% in the next week? Pretty low. The odds that IronNet might go up 20% in the next week? Pretty good based on what it’s doing. It’s making 20% moves every day. Because there’s more upside and downside, because there’s more volatility, the chances are higher that move could happen. You’re going to pay more for that option.
This can really work against you. When you pay numbers like this, when you pay for an option, when implied volatility is that high, unless it keeps making such huge moves, you could lose, even if you’re right. I’ll show you what I’m talking about. Let’s look at two, a little bit a month away, right? These are October. Options is currently September, the 16th. These expire in 30 days, one month away, and we’ll look at the money. The stock is trading for $41. We’ll get the $40 call. Here, you see it is trading 8.40 by 9.30. Let’s just call that $9 per share. All right, $9 per share. To get the upside of the stock for the next 30 days, it costs you $9, which is going to bring your cost basis all the way up here over $50.
In order for you to make a profit, the stock has to be there because you’ve got to recoup that $9 per share you paid. You see what I’m saying? It’s got to make a pretty decent move. What I meant by you can still lose money, you paid $9, such things…Let’s say, it’s holds up. It does well. It cruises. There’s a little blip and then bumps. It closes around here 49 bucks. Well, is at 41? Is it 49 and up 20%? Thinking I’m good, right? Wrong. You lost money because you paid $9 for that option, but it expires. It’s only worth 7 or 8. You’re still down money. In situations like this, you’re just paying so much for the option. You really need to be fairly certain that’s going to make a large moves. You’re paying so much for it.
On the other hand, if we contrast this with something like Netflix, and look, let’s just do the percentages here. It was a $41 stock. Okay. $41 per share. The call option is $9 per share. Your costs for 30 days of exposure to the side, 22%. Look at these numbers. You need a 22% gain to break even. You were paying 22% of the stocks value just to see what it does for the next 30 days.
Now, let’s contrast that with someone like Netflix. Once the Netflix is around 586, let’s go back to our option chain. Now much more reasonable implied volatility in for 28% versus 280%. When I had the money call here, the 585 cost us about 16 bucks per share, 16 bucks and 75. Let’s look at the numbers here. Now we have 585 a share, and it’s like 586. I’m just rounding here. Our call option is 16 bucks per share. To get the upside exposure on Netflix for the same time period, our costs instead of 22% is 2.7%. That’s all you’re really risking. By having this call option here, all you’ve got to get at 16 bucks is 602-ish. That’s where you got to get to be a breakeven. All right. Essentially, you’re risking 16 bucks a share.
You can look at this as if, let’s say, that’s all you want to risk. 15 bucks a share. If you did a stop at 16 bucks a share below the current price, you put a stop order in that would be here. All right. Let’s say a big move happened with Netflix. They announced earnings it comes down, a little bit floods down here. Yeah, you’ll be glad you have a stopper. You had the option. But what if for the next few weeks it rises back up? By owning the stock option, you’ve limited your risk to 2.7% on this trade. That’s all you’ve outputs. The $16 per share the 1,600 bucks per option. That’s the most you can lose. Even if they can go to zero, it doesn’t matter.
You can stay with this. You don’t need to worry about a stop. You can let the thing fall, see if it comes back, especially if you’ve got opposite or two to three months out and see if at the end of that exploration period, you have some money in the bank. It gives you more time to stay with the trade. Allows you not to choke the thing off too quickly with a stop loss. And once again, it is only stomachable. If you have a stock with a relatively low implied volatility, that below 40% where it makes sense. Otherwise, you’re paying so much for the option that you really got to get a monster move, and you got to get it quick if you want to profit from it.
Now, there are other times I like to trade options, and that’s to get me in and out of stocks. I’ll cover this in another video, but I use a strategy called selling naked puts, which essentially pays me to buy stocks. And then when I get those stocks, I sell covered calls to me to get out. In other words, you’re selling a put option below the current price. You’re collecting money for that.
Worst case scenario, the stock goes up or doesn’t come down. You keep the money. Best case scenario, it comes down, you get your lower price, and you keep the money. And then when that happened, you could do the same thing on the other side. You can sell call options above the current price. Basically, you own the stock from 500. You put an offer out there for 550 by selling call options, and you’re just willing to sell it at 550, and people will pay you for that as well. Again, worst case, it doesn’t go up as much as you hope, but you still keep the premium. Best case, it does go up. You sell at a higher price, and you still keep the previous. Income strategy is totally different from the basic speculation we’re looking at here where we’ve covered that in a future video.
For those wondering whether to trade the stock or the option, hopefully this video clarifies things a little bit again, think about your timeframe. Think about the volatility. Think about what you’re trying to achieve. Think about how much capital you want to risk in that situation, and then create a trade accordingly. Thanks a lot. I’ll see you on the next video.
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