One of the things I’ve learned as an adult is how to think about finances. Growing up, we didn’t talk about money, or how to grow your finances. For the most part, I heard “try to save” and “you’ll have more expenses as you get older.” I also heard “find a good job.” This is actually all good advice, but I know there is more to it than just that. My kids are still a bit too young to understand a lot of subtlety around finances, but we are talking about money, they earn their own money to spend how they want, and I hope they can hear me when I try to impart wisdom on money management.
So, with this post, I am starting to write about money. In some ways, this is merely a document of where I am in life right now, it’s also practice for me to get my thoughts written down so that I can eventually share them with the kiddos. I’ve recently dipped my toes into the option trading waters, and I thought it’d be fund to share some of those experiences. Before I dive fully into options, though, let me share my level of investing (non?) sophistication.
I work at an online stock brokerage. I work on the technology side, where I am less concerned about the business rules are more concerned about performance and reliability of our systems. At work, though, I have zero guilt about logging into my investment account, checking out the market, and placing trades. I’ve been adding funds to my account monthly and trying out various trades. To note, this is my learning or play account. Most of my investments are in a balanced portfolio of funds that I never touch. There, that was my disclaimer. To reiterate, this is my play account that I use to learn about investing. It’s money I can afford to lose without risking my retirement or livelihood. However, I didn’t get into this activity to lose money, so let’s bring in the dollars!
Once a month, I buy fractional shares in 9 different stocks and ETFs. This is called dollar cost averaging, and I will cover that in a later post. One of the products my firm offers is an easy to use tool for dollar cost averaging, and it’s been fun to use this tool over the years. I say “fun” because over time, all my stocks have risen in value and I’m in the green (made a profit) on everything. This doesn’t mean that I’m in the green every day. I check my portfolio a couple times a week, and check on how the market is performing daily. I’ve learned that some of my stocks are highly volatile. Just in this past month, I’ve been both down $200 and up $200 on just my shares of Netflix alone. A different, more industrial stock, PPG, doesn’t tend to change much on a given day and tends to reflect whatever is happening with the market in general. This is exactly the bahavior of stocks I learned in Finance class in business school. It’s been interesting to see this happen in real life, though, now that I have a stake in the game.
I remembered learning that the greater the volatility, the greater the potential profits from trading options. So, let’s trade some options!
What does trading options mean? In the simple case, buying an option means buying the right to purchase a stock at a fixed price in the future. Let’s say I like a stock, called “Extremely Awesome Corp” ticker symbol EAC. Let’s say I buy an option to buy shares for $45/share. If the stock is trading for $47/share, then I have the option to buy those shares and can choose to resell it right away to make a profit. It can get more complicated, but this is the simple “call” option type of trade.
I logged into my account, and tried to figure out pricing. Brokerages don’t usually trade for free. It turns out, that instead of buying shares, you buy option “contracts.” One contract is worth 100 shares. So, if I look at options to buy EAC for $45, I see that they are trading at $1.75. Does this mean if I pay $1.75 I can buy 100 shares of EAC for $45 each? Nope! I have to pay $175 ($1.75*100) for the right to buy those shares. Plus, I also have to pay a commission to my broker and an additional fee per contract. Let’s just assume that works out to $200 total. To make money on this trade, I need to price of EAC to go up enough so that the profit I get from exercising my option covers what I paid to buy the option and what I paid later ($4,5000 or $45*100 + commission) to get the stocks! That tends to be a bit more funds than I typically have sitting around in idle cash in my play account. However, there is another way to make money, which is just to sell the option. If I bought it for $1.75/contract and sell it for $2/contact I can make money that way without ever owning the stock itself.
This is exactly what I intend to do as I dip my toes in the option trading market. My next post will be about that first trade, 1 contract in Microsoft (MSFT), and how I fared.