The Perfect Stock for Options

Published: 08th April 2015
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Will we ever be able to find the perfect stock to buy options on? Probable not. We are not perfect, and nothing in our world is either. No need to despair, we can still be successful in our stock option trades.

However, there are some things you should definitely look for, that can get you close. Stock selection is your number one goal, even if you are going to be making option trades.

Companies that look good in one area, may really stink it up in another. You need to make sure you get the whole picture..

Many option traders just look for the right numbers on an option to trade, without giving due attention to the underlying stock. Here are some things you should look at when you make your selection:

* Margins - this means how much of every dollar in revenue does the company get to keep? If they have low margins, that is not good. They could be taking in a lot of money (which means they are doing a lot of business) but if they don't get to keep much of it, that does not help a lot. A good margin should be over 35% on gross profits, and at least 15% for net profits.

* Growth - the name of the game in corporate America. If you made 10 Billion last year, investors want to see more this year and the next. Try to find companies that grow at least 15% a year.. Keep in mind that past growth does not mean they will grow in the future, but it is a good sign (much better than a firm who did not grow last year).

* Balance Sheet - if the debt is high, the bond holders get more attention than the stock holders. The closer to zero debt the better. Look for companies with debt to Equity ratios of less than 50% - the lower the better.

* Valuation (P/E Ratio) - Look for PE ratios of less than 20. We don't want to pay too much for even big good companies. The PE is just a ratio of a company's stock price to their earnings. If a PE is at 20, that means you are paying $20 for $1 worth of earnings.

Also, compare the PE ratio with companies in the same sector.. If the stock you are looking at is selling for less than other companies in it's sector, and is earning more money, that is a good sign!. I like to look at current earnings as opposed to projected earnings. A bird in hand.

* Dividends - it is always good if the company is treating shareholders well. Look for companies that pay dividend yeilds of more than 2%. I do invest in companies that don't pay dividends if they look great in other areas, but a check is always nice if you can get it. Even if I'm buying options on the company (option owners don't get dividends), I know that stock buyers like companies who pay nice dividends.

* Investment earnings - how is the company spending their money. Are they choosing wise investments to keep their money working? If not, they may have not-too-savvy folks handling investments. Try to find equity returns of at least 15%..

If you check all these things will that guarantee you a perfect stock or option on that stock?? Again, there is no such thing, but it will help you be more successful than option traders who just look at the option numbers. If you focus on getting a great stock and company (or a lousy one if you want to short it or buy puts), your option plays will have a MUCH better chance of success..


Doug West has been teaching traders for over 10 years. He has thousands of students from all walks of life and from all over the world.
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