You Get What You Paid For Other things being equal, options that are very much in the money and have a long time to go before expiration will be priced higher than those that are out of the money and have little time until expiration. As an example, let's say you buy an option that is 20% out of the money and expires in two weeks. Even if you only pay $0.05, chances are it will expire worthless and you incur a 100% loss. After all, the option is priced at virtually nothing because there's a very slim chance that the stock will move enough in two weeks to move the option into the money. Of course, it could happen. A major unexpected event (e.g., an out-of-the-blue sudden takeover announcement or a surprisingly good or bad quarterly earnings report) could cause a huge jump or drop and result in a big win. This is why certain traders will buy way out-of-the-money calls or puts around quarterly earnings events to try to catch lightning in a bottle. As long as you realize the long odds and understand that you will probably lose 100% in the trade, there's no problem with making these speculative bets. After all, you wouldn't be risking very much and you could stand to make big percentage gains. The key is to know what you are getting into and not assume that just because an option is cheap it's automatically a great deal. Perspective From the Short Side On the other hand, if you are on the short side of the option trade, you don't necessarily want to sell the highest-priced option because the odds favor the option being exercised. As an option seller, the ideal scenario is for the option to expire, but you also don't want to sell options that have an extremely low chance of being in the money because you won't get enough in premium to make it worth your time. Thus, it makes sense to find a balance between getting a nice premium and having a small chance of the option getting exercised. Selling options can result in a steady stream of income, but if the options are exercised, you will be forced to sell (if you have a call) or buy (if you have a put) the stock. In that scenario, it's possible to incur a big loss on the trade. Conservative option strategies are to sell calls against stocks you already have or to sell cash-secured puts on stocks that you like anyway. The bottom line: Don't take options prices at face value. Study the underlying stock and analyze the risk and reward of the available options choices. Editor's Note: Our colleague Scott Chan just provided you with valuable insights into profitable trading. But other members of the Investing Daily team can help you make smart investing decisions, too. Consider Jim Pearce, chief investment strategist of our flagship publication, Personal Finance. Jim has a stellar track record at picking profitable investments. These days, he's setting his sights on the so-called Streaming Wars. As consolidation and rapid technological change revolutionize the media industry, many investors are asking: What replaces cable TV? What comes after "cord-cutting"? And more to the point, how can they get rich from it? Those are all good questions and Jim has made it his job to answer them. "The Streaming Wars" are more than just a quadrillion-dollar battle between giant media corporations. They're also an historic opportunity to make money. Want to leverage these trends for market-beating profits? Jim has pinpointed a hidden trade that's poised to reap a windfall. Click here now for details. | 
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