Choosing Good Stocks for Options Trading: A Beginner's Guide

Choosing good stocks for options trading can be a daunting task, especially for beginners. The key is to focus on stocks with high liquidity and volatility.

High liquidity means there are many buyers and sellers, which can help you quickly enter and exit trades. Volatility, on the other hand, gives you more opportunities to profit from price movements.

Stocks with a market capitalization of over $10 billion tend to have higher liquidity. This is because larger companies typically have a larger pool of investors and traders.

Look for stocks with a beta of over 1, as they tend to be more volatile and can provide more opportunities for profit.

Options trading can be a great way to diversify your portfolio and increase your potential returns. Options trading strategies can be straightforward, but there are more nuanced strategies suitable for novice traders or investors once they're comfortable with the basics.

A protective collar strategy is one such option, where you buy an out-of-the-money put option and write an out-of-the-money call option for the same stock. This can provide a safety net against potential losses.

You can also consider a bull call spread on moderate gainers, which involves buying a lower-strike call and selling a higher-strike call at the same expiration. This strategy can work well for stocks that rise in line with the market, but can also be effective with high-flying stocks.

To find stocks suitable for a bull call spread, you can look at the 52-week highs or screen for stocks with average to above-average price gains over time, something above 10 percent.

Covered Calls are a popular options trading strategy that can be a great addition to your investment portfolio. They involve selling a call option against a stock you already own, which can provide some downside protection and generate income.

To implement a covered call strategy, you'll need to buy 100 shares of the underlying asset and sell a call option against those shares. This is a straightforward process that can be completed through your brokerage account.

The key benefit of covered calls is that they can provide limited downside protection in the form of the premium received when selling the call option. This can be especially useful if you're expecting no change or a slight increase in the underlying's price.

Here are the characteristics of a covered call strategy:

In return for selling the call option, you agree to sell shares of the underlying at the option's strike price, thereby capping your upside potential. This means that if the share price rises above the strike price before expiration, the short call option can be exercised and you'll have to deliver shares of the underlying at the option's strike price, even if it's below the market price.

A long straddle is a great way to capitalize on future volatility without taking a bet on the direction of the price move. It involves buying both a call option and a put option at the same strike price and expiration on the same underlying.

The investor purchases two at-the-money options, making it more expensive than some other strategies. This is because you're essentially buying two options at once.

Suppose you expect a stock to experience large price fluctuations following an earnings announcement. Currently, the stock price is $100. You create a straddle by purchasing both a $5 put option and a $5 call option at a $100 strike price which expires on Jan. 30.

The net option premium for this straddle is $10. This is the cost of creating the straddle. The trader would realize a profit if the price of the underlying security was above $110 or below $90 at the time of expiration.

A long straddle can only lose a maximum of what you paid for it. This is a key benefit of this strategy. The maximum reward is theoretically unlimited to the upside. If the stock price goes to zero, you would make a maximum of $20 if you own a $20 straddle.

If you're looking to diversify your options trading strategies, consider the Long Strangle Strategy. This involves buying an out-of-the-money call option and an out-of-the-money put option with the same expiration date but different strike prices.

The Long Strangle Strategy requires the stock to move significantly in either direction to be profitable. For example, if you buy a call option with a strike price of $50 and a put option with a strike price of $30, the stock needs to move above $50 or below $30.

Vertical Spreads are another strategy to consider. They involve buying and selling options of the same type and expiration date but at different strike prices. This can be a cost-effective way to trade options, as you receive the premium from the option you sold.

A Vertical Spread can be constructed as either a bull or bear spread, profiting when the market rises or falls, respectively. The potential upside is limited to outcomes between the strike prices, however.

The Protective Collar Strategy is a way to protect your investment from losses on the downside, while also limiting your gains on the upside. This strategy involves buying a put option to cover your long position in the stock, and at the same time selling a call option for the same stock.

You can think of a protective collar as a way to put a cap on your potential losses, while also limiting your potential gains. This can be a good strategy for traders who own the underlying asset and want to protect against a decline in the short run, but still have a bullish sentiment in the long run.

To implement a protective collar, you'll need to buy an OTM (out-of-the-money) put option, while selling an OTM call option for the same stock. This will give you a floor below which you can't lose more, but it will also limit your potential gains on the upside.

For example, let's say you own 1,000 shares of Coca-Cola (KO) at a price of $44, and you want to protect your investment from a decline in the next two months. You can buy 10 OTM put options at a strike price of $40, and sell 10 OTM call options at a strike price of $42. This will give you a floor of $40 below which you can't lose more, while also limiting your potential gains on the upside.

Here's a summary of the key points to consider when implementing a protective collar:

By using a protective collar, you can limit your potential losses on the downside, while also limiting your potential gains on the upside. This can be a good strategy for traders who want to protect their investments from losses, while also managing their risk.

To find great stocks for options trading, you can screen for high dividend stocks with available options at your broker. Look for companies that are well poised to succeed and have a favorable climate for dividend stocks.

You can also search for long-term winners that have plenty of room left to run. These stocks are likely to appear on lists of stocks making 52-week highs, or you can use a broker to search for stocks with compounded annual gains that outpace the S&P 500 index.

Some key metrics to look for include average to above-average price gains over time, something above 10 percent, and stocks that have been long-term gainers. You can find these stocks by searching for 52-week highs or using a broker to screen for stocks with good momentum.

Here are some specific ways to find great stocks for options trading:

Before you start selecting your stocks, take a step back and assess your readiness for stock trading. Options trading can be more complex and riskier than stock trading.

Being honest about your risk tolerance is crucial. You need to be aware of your ability to stomach market fluctuations and potential losses.

Understanding your investment goals is also vital. Are you looking for short-term gains or long-term growth? Knowing your objectives will help you make informed decisions.

Market trends and data interpretation are key skills for stock trading. You should have a good grasp of these concepts to make informed decisions.

Volatility can be a challenge in stock trading. You need to be prepared for unexpected market movements and be able to adapt your strategy accordingly.

Dedicating time to stock trading is essential. It requires regular monitoring and analysis of market trends and data.

If you're looking to buy a call option, you'll need to consider the strike price, premium, and expiration date. For instance, if you expect Apple's share price to climb higher before the end of the year, you can focus on options expiring in January of the following year.

Here are some options for Apple stock expiring in January of the following year:

If you buy the options with the $145 strike price, you'd pay $1,120, which is the premium times 100 shares.

Buying call options on dividend payers can also be a smart move, as options price in a stock's dividend payments, making call options less expensive and put options more expensive.

To find stocks for this strategy, you can screen for high dividend stocks with available options at your broker. Look for companies that are well-poised to succeed and have a favorable climate for dividend stocks to rise at an above-average rate.

A bull call spread can be an effective strategy for stocks that are poised to gain even moderately. In a bull call spread, you buy a lower-strike call and sell a higher-strike call at the same expiration, partially offsetting the cost of the trade.

Here are some stocks that may be suitable for a bull call spread:

By using options, you can gain increased exposure to a stock without using a lot of cash. Instead of buying the shares directly, you can buy a call option for a much lower price. As the stock increases in value, the value of the call option also increases, and you have the option of selling that option before its expiration date.

For example, if a trader wants to invest $5,000 in Apple, they can purchase 30 shares for $4,950. However, if they buy nine call options with a strike price of $165 that expires about a month from now, they can make a deal on 900 shares. If the stock price increases 10% to $181.50 at expiration, the option will expire in the money and be worth $16.50 per share, or $14,850 on 900 shares.

Stock Market Indexes are a great way to understand the broader market trends and identify potential stocks to trade. They are essentially a collection of stocks that represent a particular segment of the market.

You can find the major indexes in the top ETFs, such as the SPDR S&P 500 ETF Trust (SPY) and the Dow Jones Industrial ETF (DIA), which are highly liquid and easy to trade.

The SPY ETF tracks the S&P 500 index, which contains 500 of the largest and most liquid stocks in the US market. This makes it a great representation of the overall market.

Here are some of the major indexes and the ETFs that track them:

These indexes can help you identify the stocks that are performing well and make informed decisions about your trades.

Infosys Limited is a reputable Indian software development and consulting company. It offers a wide range of services, including cloud solutions and digital transformation.

The stock is actively traded on both the BSE and NSE, making it an ideal alternative for options trading for investors. This high volatility and liquidity are key factors that contribute to its popularity.

As of September 2021, Infosys' market value exceeded $100 billion.

Bharat Petroleum Corporation Limited is a prominent player in India's oil and gas sector.

Its shares are actively traded on the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE), making it a popular choice among investors.

Strong liquidity and significant volatility characterize this company, attracting the attention of options traders.

Robust trading volumes make it a preferred choice for investors looking to engage in options trading.

Its popularity on the stock exchanges highlights its importance in the financial world, appealing to both experienced traders and newcomers.

The company's presence underscores its role as a key player in the market, offering opportunities for various trading strategies.

Larsen & Toubro Limited is the largest engineering and construction company in India.

Its stock is heavily traded on the BSE and NSE, making it a top pick for options traders due to its exceptional liquidity.

This stock's steady trade activity and dependable market presence are the main causes of its broad popularity.

Liquidity is a key factor in options trading, and Larsen & Toubro Limited's stock offers it in abundance.

Liquidity is a crucial factor in stock selection, especially for options traders. It's the combination of daily volume and open interest that makes an option contract liquid.

High volume equals high liquidity, with daily volume being the number of times a contract was traded on a specific day. For example, if the daily volume of a General Motors $10 Dec 20 call option contract is 15, it's not enough to make me consider trading it.

The more liquid an option contract is, the easier it is to buy and sell at good prices. A high open interest, on the other hand, indicates a large number of buyers and sellers, making it easier to fill option orders.

A good rule of thumb is to look for option contracts with at least 100 to 1000+ volume daily and at least 1000+ open interest. This increases the chances of getting a good price for your trade.

Here are some key points to consider when evaluating liquidity:

These factors can help you identify liquid option contracts that are suitable for trading.

Moving Averages can be a valuable tool in your stock selection arsenal. They smooth out price action and filter out random price fluctuations.

Simple Moving Averages (SMAs) are a great indicator of going to swing trade options. They can help identify trends and confirm long-term moves.

Exponential Moving Averages (EMAs) are ideal for day trading, particularly with the 9 and 20 EMAs. These can help you get a good entry and exit.

VWAP (Volume-Weighted Average Price) is another great indicator to use alongside EMA/SMA and other technical analysis tools.