My goal for this lesson is to explain option trading in an easy-to-understand manner so that you walk away with a basic understanding of trading options. This is Lesson 1, Module 1 of the free options trading course (the table of contents is at the bottom of each lesson in this course).
To explain options trading, I’ll walk through the example I shared with my neighbor when he asked why I was always home.
I told him I traded options for a living, and he looked at me like I had three eyeballs. He then said, “What’s that? I’ve never heard of options trading.”
It’s a fairly typical response.
Option contracts are a relatively unknown investment tool, even though they were created for mainstream investors in the 1970s. They were made as a form of insurance for buy-and-hold investors.
In my opinion, options were never meant to be traded. Still, I assume somewhere along the way, a creative (or greedy) person discovered the profit potential of options (they can quickly turn small sums of money into large sums). Thus, a new industry called “Options Trading” was created.
The profit potential of options is insane. You can make AND lose 50-100% of your money in weeks, if not days. Hence, those who have heard of options are usually told to stay away because options trading is risky (partly true and partly false).
Before I get ahead of myself, let me cover the boring technical definition of options, and then I’ll simplify it for us mere mortals who prefer plain English over geek speak. I will only be referring to trading stock options, even though options can be traded on other securities, such as commodities.
Stock Option: a contract that gives the owner the right (or option) to buy or sell a stock at an agreed upon price and at an agreed upon date.
An example of what this looks like...
That option would give me the right to buy stock XYZ for $50 a share on or before December 2025.
That’s an oversimplified example. We will go into more detail as you continue to go through this free options course.
So a stock option is not a physical thing like owning shares in a company. Instead, it's a contract or agreement between two parties.
When you own stock (or shares), you own a piece of the company. When the company's value goes up, so does your shares price, and then you have the opportunity to sell your stock shares at a higher price.
However, a stock option is an agreement, or a contract, where one party agrees to deliver something (stock shares) to another party within a specific time period and for a specific price.
So trading stock options is essentially the business of buying and selling contracts (stock option contracts).
It is no different from the contract you sign to buy a house or a contract you have with a lawyer or musician. It's just a contract.
However, the above definitions don’t explain option trading so you understand how a young 34-year-old could retire from Corporate America from using these mysterious contracts, so the next logical question my neighbor asked me was this...
First, options traders make their money the same way stock traders do. Stock traders make their money when the asset they bought (stock shares) increases in price. Once that happens, they sell their shares for a profit. Options traders make their money when the asset they bought (options contract) increases in price. They then sell their contract at a higher price than what they paid.
NOTE: I am only referring to the buying side of options trading. There is a way to make money by selling stock options, but this lesson only covers buying options.
Second, options are leveraged. One of the best ways to grow wealth fast is to use leverage conservatively and responsibly.
Let me cover an example of leverage you may be familiar with (down payments on cars, homes, etc.). Example: You tie up a $200,000 home with only a $1,000 earnest money deposit. You control a large asset with a small sum of money (leverage).
Let’s pretend you get lucky, and the house goes up to $250,000 before you have a chance to buy it. Remember, your contract says you can buy a $250K house for only $200K. Do you think you can assign or sell your contract to someone else for $2,000?
Now that you have a mini-lesson on leverage let me return to options trading.
If stock XYZ goes up $5 (50 to 55), that option contract may also go up $5 (a 100% return on my investment). Remember, the Option controls the shares and benefits from the movement of the stock (think back to the real estate contract). The “contract” controls the large asset, but I only have to pay a small sum for the contract.
At this point, I sell my contract back into the market and pocket my 100% ROI. Note that this is a 100% return on my investment, not my account size.
So I make money with stock options by placing small, low-risk bets and generating high returns of 50-100% on each bet. The total profit on all those small bets might grow my OVERALL account by 15% a year. Rinse and repeat for 5-10 years while combining with a high savings rate, and it’s staggering how big your account can get.
$10,000 earning 15% a year, with personal contributions of $500 a month, grows into $162,278 in only ten years.
So that’s the written summary of what I have to explain to neighbors and everyone else who asks me what I do for a living. Of course, there is more to it which is why you have a complete course to teach you.
If you’re ready to learn more, check out the free options trading course links below.
I don't know what has brought you to my page. Maybe you are interested in options to help you reduce the risk of your other stock market holdings.
Maybe you are looking for a way to generate a little additional income for retirement. Or maybe you've just heard about options, you're not sure what they are, and you want a simple step-by-step guide to understanding them and getting started with them.
I have no idea if options are even right for you, but I do promise to show you what has worked for me and the exact steps I've taken to use them to earn additional income, protect my investments, and to experience freedom in my life.
If you want to learn more, I invite you to download a FREE video case study on how to trade options like Warren Buffett.
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Wealth Building Resources
Free Video Case Study (Newsletter)
Options Trading Made Simple Book (My Kindle book)
Options Wealth Academy (High End Training Program co-founded by Travis)
Free Options Course Learning Modules
Module 1: Option Basics
Module 2: Option Value
Module 3: Basic Strategies
Module 4: Stock Charts
Module 5: Technical Indicators
Module 6: The 7-step process I use to trade stock options