Options🍌 can be used to implement a wide array of trading strategies, ranging from a simple buy and sell to complex spreads with names like butterflies and condors. In addition, options are available on a vast range of stocks, currencies, commodities, exchange-traded funds, and futures contracts.

There are often dozens of strike prices and expiration dates available for each asset, which can pose a challenge to the option novice because th🉐e plethora of choices available makes it sometimes difficult to identify a suitable option to trade. 

Finding the Right Option

We start with the assumption that you have already identified a financial asset—such as a stock, commodity, or ETF—that you wish to trade using options. Not all stocks will have options available. You may have picked this 澳洲幸运5开奖号码历史查询:underlying using a 澳洲幸运5开奖号码历史查询:stock screener, by employing your own analysis, or by using third-party research. Regardless of the method of selection, 澳洲幸运5开奖号码历史查询:onc𓂃e you have identified🌱 the underlying asset to trade, there are six steps for finding the💯 r🐟ight option:

1. Formulate your investment objective.
2. Determine your risk-reward payoff.
3. Check the volatility.
4. Identify events.
5. Devise a strategy.
6. Establish option parameters.

The six steps follow a logical thought process that makes it easier to pick a specific option for trading. Let's break down what each of these steps involves.

1. Option Objective

The starting point when making any investment is 🧸your investment objective, and options trading is no different. What objective do you want to achieve with your option trade? Is it to speculate on a bullish or bearish view of the underlying asset? Or is it to hedge potential downside risk on a stock in which you have a significant position?

Are you putting on the trade to earn income from selling option premiums? For example, is the strategy part of a 澳洲幸运5开奖号码历史查询:covered call against an existing stock position or are you 澳洲幸运5开奖号码历史查询:writing puts on a stock that you want to own? Using options to generate income is a vastly different🅷 approach compared to buying 🐈options to speculate or hedge.

Your first step is ꦇto formulate what the objective of the trade is because it forms the foundation for the subsequent steps. 

2. Risk/Reward

The next step is to determine your 澳洲幸运5开奖号码历史查询:risk/reward payoff, which should be dependent on your risk tolerance or appetite for 🌜risk.

If you are a conservative investor or trader, then aggressive strategies such as writing puts or buying a large amount of deep 澳洲幸运5开奖号码历史查询:out-of-the-money (OTM) options may not be sui🍌ted to you. Every option strategy has a well-defined risk and reward profile, so make sure you understand 🌳it thoroughly.

3. Check the Volatility

澳洲幸运5开奖号码历史查询:Implied volatility is one of the most important determinants of an option’s price, so get a good read on the level of implied volatility for the options you are considering. Compare the level of implied volatility with the stock’s 澳洲幸运5开奖号码历史查询:historical volatility and the level of volaღtility in the broad market, since this will b♋e a key factor in identifying your option trade/strategy.

Implied volatility lets you know whether other traders are expecting the stock to move a lot or not. High implied volatility will push up premiums, making writing an option more attractive, assuming the trader thinks volatility will not keep increasing (which could increase the chance of the option being 澳洲幸运5开奖号码历史查询:exercised).

Low implied volatility means cheaper option premiums, which is good for buying options if a trader expects the underlying stock will mo🉐ve enough to increase the value of the options.

4. Identify Events

Events can be🍒 classified into two broad categories: market-wide and stock-specific. Market-wide events are those that impact the broad markets, such as Federal Reserve announcements and economic data releases. Stock-specific events are things like earnings reports, product launches, and spinoffs.

An event can have a significant effect on implied volatility before its actual occurrence, and the event can have a huge impact on the stock price when it does 🍰occur. So do you want to capitalize on the surge in volatility before a key event, or would you rather wait on the sidelines unt🧸il things settle down?

Identifying events that may impact the underlying asset can help you decide on the appropriate time frame anཧd expiration date for your option trade.

5. Select a Strategy

Based on the analysis condꦇucted in the previous steps, you now know your investment objective, desired risk-reward payoff, level of implied and historical volatility, and key events that may affect the underlying 🍎asset. Going through the four steps makes it much easier to identify a specific option strategy that could meet your needs.

For example, let’s say you are a conservative investor with a sizable stock portfolio and want to earn premium income before companies commence reporting their quarterly earnings in a couple of months. You may, therefore, opt for a covered call 澳洲幸运5开奖号码历史查询:writing strategy, which involves writing calls on some or all of the stocks in your portfolio🧜.

As another example, if you are an aggressive investor who likes long shots and is convinced that the markets are hea🤪ded for a big decline within six months, you may decide to buy puts on major stock indices.

6. Establish Parameters

Now that you have identified the specific option strategy you want to implement, all that remains is to establish option parameters like expiration dates, strike prices, and option deltas. For example, you may want to buy a call with the longest possible expiratio💙n but at the lowest possible cost, in which case an out-of-the-money call may be suitable. Conversely, if you desire🍷 a call with a high delta, you may prefer an in-the-money option.

Examples Using These Steps

Here are two hypothetical examples where the six steps are used by different ✤types of💮 traders.

Say a conservative investor owns 1,000 shares of McDonald's (MCD) a🦩nd is concerned about the possib🥀ility of a 5%+ decline in the stock over the next few months. The investor does not want to sell the stock but does want protection against a possible decline:

• Objective: Hedge downside risk in current McDonald’s holding (1,000 shares); the stock (MCD) is trading at $161.48.
• Risk/Reward: The investor does not mind a little risk as long as it is quantifiable, but is loath to take on 澳洲幸运5开奖号码历史查询:unlimited risk.
• Volatility: Implied volatility on ITM 澳洲幸运5开奖号码历史查询:put options (strike price of $165) is 17.38% for one-month puts and 16.4% for three-month puts. Market volatility, as measured by the 澳洲幸运5开奖号码历史查询:Cboe Volatility Index (VIX), is 13.08%.
• Events: The investor wants a hedge that extends past McDonald’s earnings report. Earnings come out in just over two months, which means the options should extend about three months out.
• Strategy: Buy puts to hedge the risk of a decline in the underlying stock.
• Option parameters: Three-month $165-strike-price puts are available for $7.15.

Since the investor wants to hedge the stock position past earnings, they buy the three-month $165 puts. The total cost of the put position to hedge 1,000 shares of MCD is $7🦄,150 ($7.15 x 10꧅0 shares per contract x 10 contracts). This cost excludes commissions.

If the stock drops, the investor is hedged, as the gain on the put option will likely offset the loss in the stock. If the stock stays flat and is trading unchanged at $161.48 very shortly before the puts expire, the puts would have an 澳洲幸运5开奖号码历史查询:intrinsic value of $3.52 ($165 - $161.48), which means that the investor could recoup about $🐷3,520 of the amount invested in the puts by selling the puts to close the position.

If the stock price goes up above $165, the investor profits from the increase in value of the 1,000 shares but forfeꦏits the $7,150 paid on the op♈tions.

Now, assume an aggressive trader is bullish on the prospects of Bank of America (BAC) and has $1,000 to implement an options tr💦ading strategy:

• Objective: Buy speculative calls on Bank of America. The stock is trading at $30.55.
• Risk/Reward: The investor does not mind losing the entire investment of $1,000, but wants to get as many options as possible to maximize potential profit.
• Volatility: Implied volatility on OTM call options (strike price of $32) is 16.9% for one-month calls and 20.04% for four-month calls. Market volatility as measured by the CBOE Volatility Index (VIX) is 13.08%.
• Events: None, the company just had earnings so it will be a few months before the next earnings announcement. The investor is not concerned with earnings right now but believes the stock market will rise over the next few months and believes this stock will do especially well.
• Strategy: Buy OTM calls to speculate on a surge in the stock price.
• Option parameters: Four-month $32 calls on BAC are available at $0.84, and four-month $33 calls are offered at $0.52.

Since the investor wants to purchase as many cheap calls as possible, they opt for the four-month $33 calls. Excluding commissions, 19 contracts are bought for $0.52 each, for a cash outlay of $988 (19 x $0.52 x 100 = $988), plus commissions.

The maximum gain is theoretically infinite. If a global banking conglomerate comes along and offers to acquire Bank of America for $40 in the next couple of months, the $33 calls would be worth at least $7 each, and the option position would be worth $13,300. The breakeven point on the trade is the $33 + $0.52, or $33.52.

Note that the strike price of $33 is 8% higher than the stock’s current price. The investor must be confident that the price can move up by at least 8% in the next four months. If the price isn't above the $33 strike price at expiry, the investor will have lost the $988.

The Bottom Line

While the wide range of strike prices and expiration dates may make it challenging for an inexperienced investor to zero in on a specific option, the six steps outli🐼ned here follow a logical thought process that may help in selecting an option to trade. Define your objective, assess the risk/reward, look at volatility, consider events, plan out your strategy, and define your options parameters.