What to Trade Options on

Nasdaq srock market display

I often get the question ‘What should I trade options on?’. Options trading is a great way to make money in the stock market. But to trade options, you will need an underlying asset to trade options on. The question is what should this underlying ideally be? There are different possibilities to choose from. Before I begin to explain the different choices it is important to understand that no matter what you choose, it should be liquid enough. Not every asset does offer options to trade, but typically most of the liquid securities do offer options.

 

Stocks

This is the most straightforward way and probably also the most common way to trade options. Many stocks offer options.

Pros

  • There are thousands if not even millions of different stocks that are optionable. There are endless different stocks to choose from. This is the way to go for most variety.
  • To the countless already existing stocks there come even more new ones every day. Big new stocks are coming and leaving all the time. This keeps the market interesting and there probably never will be too few stocks to trade options on.
  • Additionally, stocks have events like earnings announcements. This can be a big pro for some option traders because with earnings there can come very good opportunities.

Cons

  • But on the other hand, some of these stocks have very bad liquidity.
  • Not forgetting that only some offer options and those that offer options often only offer very few or illiquid options.
  • Furthermore, stocks are the only ones on this list who can go bankrupt.

Examples of very liquid and good assets to trade options on:

AAPL (Apple Ord Shs)

BAC (Bank of America Ord Shs)

NFLX (Netflix Ord Shs)

FB (Facebook Class A Ord Shs)

JPM (JPMorgan Chase Ord Shs)

MSFT (Microsoft Ord Shs)

 

Indexes

If you don’t know what market indexes are, I recommend reading my article on market indexes.

Indexes are another good choice to trade options on. You may not be able to trade shares of the actual indexes themselves, but you certainly can trade options on them.

Pros

  • Not only the indexes but also the options for them mostly are extremely liquid. This is very good and important for trading.
  • Another great benefit of index options is that they are settled by cash. This means that you can’t get assigned stock.

Conss and p 500 price history

  • Usually, indexes have lower volatility/IV than other assets
  • Besides options on big indexes can actually be quite expensive.

Examples of very liquid and good assets to trade options on:

SPX (S&P 500®)

DJX (Dow Jones)

RUT (Russell 2000®)

NDX (NASDAQ-100®)

 

ETF’s

ETF’s can be traded just like normal stocks on the stock market. They track indexes, commodities, bonds or other things. They behave similar to mutual funds but have lower fees and often higher liquidity. ETF’s, therefore, can be quite attractive for option traders. Note some ETF’s don’t track their assets exactly, some offer inverse tracking (doing exactly the opposite), double, triple… tracking (move 2-3… times more than the actual index, commodity…).

Pros

  • There are many ETF’s for many different financial sectors. For example, you can trade ETF’s in commodities, social media, car industry, financials etc.
  • ETF’s usually have less unpredictable, sudden big moves. This makes them very good for some option strategies.
  • ETF’s and ETF options often are very liquid and have very deep markets.

Cons

  • ETF’s sometimes are repriced if they strive too far away from their assets price. This can mess up some trades.
  • ETF’s can have weird pricing, especially the more advanced ones (inverse, double, triple…).
  • Some smaller, not so popular ETF’s can have illiquid options.

Examples of very liquid and good assets to trade options on:

SPY (SPDR S&P 500 ETF Trust). This is probably the asset with the most options traded ever.

IWM (iShares Russell 2000 ETF)

QQQ (PowerShares QQQ Trust ETF Series 1)

USO (United States Oil ETF)

EEM (iShares MSCI Emerging Markets ETF)

DIA (SPDR Dow Jones Industrial Average ETF)

 

Which should you choose

First of all, there is not one correct answer to this question. You can’t really go too wrong with any of these. The most important thing is still picking liquid securities. Otherwise, I would say it really depends on what you are looking for and where you are at. For beginners, I would probably just recommend some bigger indexes or ETF’s tracking some big indexes. Especially ETF’s like the SPY are ideal for options trading. The reasons why I would recommend these bigger indexes for smaller and newer option traders are:

1. They are less volatile and therefore have less unpredictable moves and

2. They offer integrated diversification.

New traders with smaller accounts probably won’t have too many positions on at the same time. Thus they can’t really have a too diversified portfolio. But as long as they trade in big indexes/ETF’s tracking big indexes (like the SPY) they will have some diversification because these assets contain many different stocks. Generally, I would say that you can’t really go wrong with these big indexes.

But generally, it is a good idea to trade all three. As long as you pick liquid securities, it doesn’t really matter. It is actually a good idea to have some positions in all of these. This will automatically diversify your portfolio to some degree.

Furthermore, criteria like implied volatility, liquidity, upcoming events… are more important than the asset itself. So rather pay attention to the criteria relevant for your trading strategy than the underlying asset itself.

 

 


This Article is part of the Intermediate Option Trading Course. If you are reading the article as a part of the course, you can continue to the next lesson: HERE

4 Replies to “What to Trade Options on”

  1. Hey thanks for this articl.

    I have been interested in trading for a number of years but have never had the money to invest. Is there a way of getting started with only minimal investment or do you need to invest big to return big?

    I do not really know much about the markets and would be very weary about investing without the correct knowledge

    1. Hey Craig,

      Sure you can start with little capital. I would recommend to have at least 1000 to start with. But no matter how much money you have you should always educate yourself before risking any of that money. If you are interested in learning more about options and how to make money with them check out the education section here.

  2. Great article.

    I think a lot of people find options confusing and don’t really understand what they are. I think that keeps a lot of people away from options trading.

    What a lot of people don’t realize is that as long as you’re just buying options and selling them later, you cannot lose more than your investment. The danger comes when people start selling (or writing) uncovered options. That’s when you can really lose.

    I first learned about options in the commodities (futures) markets. That was in my younger, more fearless (crazy) days. Now I stick to the options you mentioned in your article.

    1. Hey Andy,
      You are absolutely right. Options are not anything extremely risky as long as you trade them correctly. Just like you say, it is always best to trade defined risk strategies (strategies with limited risk). I would first start to trade undefined risk strategies in large trading accounts. This doesn’t mean that you can’t sell options at all. This just means that you shouldn’t sell naked options.

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