As we all know, stocks are constantly pinging around every minute of every trading day. By harnessing the power of options, you can take full advantage of those price swings.

Options can allow you to fully participate in stock movements, while only putting up a small fraction of the underlying asset value – thus magnifying your returns.

It’s like putting up a small ante to win a huge pot.

Is that risky? Not necessarily. While any investment involves the potential loss of capital, options aren’t inherently risky. In fact, they can even be used to generate predictable income, while safeguarding against market volatility and minimizing potential losses.

First things first, let’s go over some of the terminology.

The Nuts And Bolts Of Options

Option – A contract that represents an interest in 100 shares of a specified stock. There are also options on stock indexes like the S&P 500 or the Dow Jones Industrials.

Call Option – a contract conveying the right (but not the obligation) to purchase an underlying stock or security at a fixed, pre-determined price, known as the “strike” price.

Put Option – a contract conveying the right (but not the obligation) to sell an underlying stock or security at a fixed, pre-determined price.

Premium – the cost of the contract, expressed on a per-share basis. This is the amount of cash that the buyer of the option will pay upfront to the seller (or writer) for the right to buy or sell the underlying stock.

Expiration Date – the month and day on which the options contract will expire, typically at the market close.

It’s important to remember that there are always two parties involved in these trades: the buyer and the seller. As with any transaction, the buyer pays the seller. The seller will keep the premium income regardless, while the buyer hopes to profit from an up (or down) move in the stock at some point before the expiration date.

The larger the move, the more they make. If the stock moves far enough in the right direction (above the strike price for a call, below for a put), then the option is said to be “in the money”. Volatile stocks with larger price swings can lead to bigger profits, which is why they generally cost more for options buyers (larger premiums).

Putting It Into Practice

Let’s talk for just a moment about how to enter and exit an options contract. Most can be executed in just a click or two at an online broker like e*Trade, typically for little to no commission. But be aware that bid/ask spreads can vary, particularly for securities with lower trading volume.

Here’s a breakdown of what a quote looks like on Yahoo Finance. You might see an options contract for pharmacy chain CVS listed like this:

CVS230714C00075000

It really isn’t as confusing as it seems at first glance. All options quotes start with the ticker symbol of the stock, which is CVS in this case. That is followed by the expiration date — June 14, 2023 — in a year/month/day format (230714). The “C” in this case shows that the quote is for a call option. If the option is a put, that letter will be a “P.” The remainder of the quote is simply the strike price, $75, with a number of extra zeros added so the format can be used with stocks of any price.

Now, each online brokerage account interface is different. But here’s an example of what you might find…

If all of this terminology feels a little daunting, don’t let it. There will be plenty of time to get more comfortable.

For now, let’s take a step back and review why this is worth it…

Examples Of Our Previous Wins…

Options trades can easily turn routine singles and doubles into homeruns. Let me give you a couple of real-life examples that just made a bundle for many of my Takeover Trader readers.

Shortly after the newsletter was launched in June 2020, I spotted an opportunity in Roku (Nasdaq: ROKU), whose devices turn ordinary televisions into internet-connected smart TVs. The shares had dipped to $104, from a recent peak near $140. So I advised subscribers to buy a call option expiring in August with a strike price of $115. We entered the contract at a price of $8.65.

As you can see from the chart below, the stock wasted no time hitting the $115 level – advancing to $149.98 on July 9. That’s a nice 43% pop in the common shares (which we also bought). But the options zoomed from $8.65 to $38.40 – for a magnified gain of 344%.

And it’s not just the size of these gains that can supercharge your portfolio – it’s the speed. Many expect the overall market to deliver a modest 7% average annual return going forward. At that pace, it will take over a decade to double your money. It’s a mathematical fact. But with options, triple-digit gains are possible in weeks, or even days.

A few months later, on November 3, I recommended that my readers purchase a $90 call option on PapaJohn’s Pizza (Nasdaq: PZZA). The option was trading for just $2 at the time. On November 5, PZZA shot up from the mid-$70s to the low-$80s on a robust quarterly earnings report. In turn, the January call option climbed to $3.40.

We exited the next day, banking a tasty profit of 70% in just 72 hours.

Closing Thoughts

That’s the secret power of options.

It’s okay if your primary focus of investing is centered around, say, income. Or value investing. I still think options can have a valuable place in your portfolio. Once you’re comfortable, I hope you’ll consider using them when the time is right.

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