Options trading is becoming increasingly popular among traders because of its fascinating and versatile features. The kind of flexibility and leverage options provide, plus the rise of technology makes it a great tool for earning money. Options are derivative instruments which means that their prices are dependent on some other asset, usually known as ‘underlying asset.’ This asset can be a stock, an index, a commodity or anything else. Stock options are among the most widely traded options. But there are hundreds of stocks on which options can be traded. How to pick the best stocks for options trading? Well, this is exactly what we are going to explain in this post. Keep reading to find out.
Picking the stocks for options trading
Honestly speaking, there is no holy grail to it. You are only going to learn it with experience. That said, below are the few guidelines that you must always keep in mind while picking the stocks for options trading.
Make sure that your strategy matches with your opinion about the stock
This one is commonsense. Just because you like a particular strategy, it doesn’t mean that it can be traded in all stocks at all time. If you want to trade a long straddle, you can’t simply go and buy ATM Calls and Puts of your favorite stock. You have to choose those stocks which you think, are going to show a significant surge in volatility in the future.
Consider the liquidity factor
Before making any trade, make sure that there is sufficient liquidity in your chosen stock’s options for you to not only entering the trade but also exiting it whenever you want, without paying heavy slippages. Don’t get confused between the liquidity of stock and liquidity of its options. If a stock is liquid, it doesn’t mean that its options are also liquid enough.
Stick to your watchlist
Create a watchlist of stocks that you have been tracking for a long time and stick to only those stocks for options trading as you are more familiar with the movements and behaviors of these stocks. An even better option would be to stick to only those stocks on which you were able to make correct predictions in the past. This is especially recommended if you are not much experienced.
Keep track of the volatility
Volatility is an important factor in options trading. Make sure that you know the volatility figures for the stocks in which you are trading. It is always a good idea to ignore those stocks which are extremely volatile.
Don’t forget about implied volatility (IV)
Implied volatility is a major determinant of any option’s price. Price rises when IV rises and falls when IV falls. Hence, it is important to always check the implied volatility before buying or selling an option. Many times, traders make a correct prediction of the stock’s price but still lose money in options trading just because they ignore IV. When buying options, always look for low IV and aim for high IV when selling.
Check for any upcoming event
It is difficult to trade options for those stocks, in which any special event such as earnings announcement, board meeting, etc. is due in the near future. This is because IVs are generally at sky-highs at that time. And when the event passes, IV drops sharply. This coupled with heavy movement in stock price, cause wild fluctuations in option prices. Thus it is recommended to stay away from these stocks.
Also Read: 5 qualities of a Successful Options trader
So, how do we pick the best stocks for options trading? Well, options trading has the potential for both huge profits as well as enormous losses. No one can tell you the secret for success. Only your hard work, patience and experience can teach you that. However, following the above points will surely increase your odds of winning.