Options give you the ability to overlay a short-term investing strategy on top of a stock. If the stock does what you expect it to do, you could turbocharge your gains or even generate what feels like free income. This ability to magnify your returns makes options trading attractive to traders looking for a quick gain, though long-term investors can use them effectively, too.
Here’s how to identify the best stocks for options trading and what you need to know.
The best stocks for options trading
To put it succinctly, there are no best stocks for options trading generally. However, you can identify great candidates for specific option strategies or approaches. That is, not all stocks are good for “options” as a whole, but some stocks may be a great place to overlay targeted options strategies or to take advantage of the drivers of option pricing such as volatility or time decay.
For example, buying put options – which profit on the decline of a stock – is not often a great strategy for a long-term winner such as Amazon , which has risen steadily higher over the last decade and more. But Amazon could be a great candidate for option strategies that gain when the stock rises. These include call options or more advanced option strategies such as a bull call spread, a strategy that can help you increase your percentage return within certain limits.
So what you want to do is match your option strategy to how you expect the stock to perform. The great news for traders is that options allow you to set up a number of different strategies to match your expectations for the stock’s performance, whether it’s up, down or sideways.
With that understanding, many stocks could be great for options traders, depending on the strategy they want to match with the stock. Below are a few ways to find stocks that could fit well with a specific option strategy.
5 places to find great stocks for options
Let’s identify a potential option strategy and then identify where you might seek out the stocks that could fit well.
1. Buy call options on long-term winners
Call options rise in price when the underlying stock rises in price, and this basic option strategy gives the call owner the ability to profit with unlimited upside for the duration of the option contract. As long as the stock keeps rising, the call can keep increasing in value with no cap. So buying calls can be a great way to play a long-term winner that can keep rising for a while, allowing you to multiply your money many times, depending on the strike price you select . If you select a long-lived option you can give your option more room to run and time to be right.
Where can you find stocks for this strategy: You want to find stocks that are poised to win over the long-term, so look for long-term winners that have plenty of room left to run.
2. Buy put options on falling stocks
Put options rise in price when the underlying stock falls in price, and this basic option strategy gives the put owner the ability to multiply their money over the duration of the option contract. As long as the stock keeps falling, the put can keep rising in value, capped only when the stock reaches $0. So buying puts can be a good way to play a stock that is likely to fall for some time, and you can magnify your potential gains more than short-selling with potentially lower risk.
Where can you find stocks for this strategy: You want to find stocks that are poised to fall over time, so look for stocks with a short-term or long-term downtrend.
3. Set up a bull call spread on moderate gainers
A bull call spread can be an effective strategy for stocks that are poised to gain even moderately. In a bull call spread you buy a lower-strike call and sell a higher-strike call at the same expiration, partially offsetting the cost of the trade. Your profit tops out at the higher-priced strike, but your net investment (on a percentage basis) actually rises faster between the two strikes than if you purchased only a call. While your upside is capped here, you could still double or triple your money with a moderate gain in the stock, depending on the strikes and expiration you set up.
Where can you find stocks for this strategy: This strategy can work well for stocks that rise more in line with the market as a whole, though it can also work with high-flying stocks, too.
4. Sell put options to play volatility on recently fallen stocks
Volatility is one of the key drivers of options prices, and stocks with higher expected volatility have higher options premiums, all else equal. Some traders may take advantage by selling put options on stocks that have temporarily high volatility but where volatility may decline during the option’s lifetime. The put delivers a premium payment upfront, and the trader will likely capture the full premium if the stock does not fall below the strike by expiration. When you’re short options, you also benefit from the time decay inherent in options, and the option price ticks down day by day.
Where can you find stocks for this strategy: This strategy works better with stocks where volatility may be only temporarily high.
5. Buy calls on dividend payers
Options price in a stock’s dividend payments, meaning that call options on dividend stocks are less expensive (and put options more expensive) than on non-dividend-paying stocks, all else equal. If it’s a favorable market for dividend stocks to rise at an above-average rate, then it could make sense to purchase options on dividend stocks. You could get an above-average return while paying a favorable price for your calls.
Where can you find stocks for this strategy:
Bottom line
While there’s no stock that’s universally good for all options strategies at all times, you should target stocks based on the type of option strategy you want to use. By correctly matching the option strategy with the right type of stock you’re more likely to make winning option trades.