The popularity and volatility of tech stocks in the options market make them common selections for online traders who are looking to profit from these stocks’ benefits. Tech companies usually exhibit higher price-to-earnings ratios than stocks in other sections, so there’s great potential to make some decent money with these investments. Tech companies like Amazon, Tesla, and Nvidia promise substantial future stock growth by being on the cutting edge of new technologies and developments within their sectors. Trading options on these stocks can be a challenge, but the profit potential can be extraordinary when done right.
Trading options on tech stocks requires specific strategies due to their fast growth, regulatory risks, and earnings volatility—we’ve prepared this guide with 12 helpful tips for options trading with tech stocks to help you successfully navigate the fast-paced, volatile, and sometimes unpredictable nature of that market. We hope these expert tips can help you make informed decisions when trading options on tech stocks. Keep reading to learn how to finesse your tech stock investments into a fruitful return!
Understand the Volatility of Tech Stocks
Tech stocks are the most volatile due to earnings growth, innovation, and market sentiment. A lot of traders and investors seek out tech stocks. This can make them vulnerable to market cycles, and they’re valued at high price-earnings multiples. Due to all these factors, tech stocks’ price movements are largely linked to expected earnings, which can lead to increased implied volatility.
Higher implied volatility (IV) can lead to more expensive options premiums, which means that it can cost more than non-tech stocks to trade. The other thing this means for traders is that they must use strategies that work well for managing high IV with these kinds of stocks. A few of the common approaches include selling options instead of buying during peak volatility.
Pay Attention to Earnings Reports
Tech stocks often experience large price swings around earnings announcements, so it’s key for traders to pay attention to earnings reports to time their trades correctly. Because you can never tell which way the stock price will be moving before an earnings report is released, one of the best strategies to use in these circumstances is a straddle or strangle trade, where you can take advantage of the volatility experienced around these earnings announcements.
- Straddles—There are two types of straddle trades: the long straddle and the short straddle. Long straddles can be used to profit from volatility in the rising and falling markets without the trader having to correctly predict the actual direction. Short straddles are best used in markets where there’s only expected to be low volatility, keeping the stock price close to the set strike price.
- Strangles—Like straddles, strangles come in a long and a short version. The long strangle profits from volatility price movements in either direction, and it’s a much cheaper option for traders compared to the long straddle. The short strangle profits when there’s low volatility (much like a short straddle) and the stock price stays near the strike price.
When trading around earnings reports, traders should use short-term expirations on their tech stocks to reap the benefits of volatility around the event. The expiration date should be set for the time immediately following the announcement if you want to take advantage of short-term earnings volatility. It could greatly benefit options traders to use weekly options in these scenarios.
Use Implied Volatility (IV) to Your Advantage
Implied volatility is a measurement of options in online trading that shows how current implied volatility compares with its historical range. The rule of thumb for traders using IV as a trading tool is that a higher IV rank indicates a relatively high current IV and a lower IV rank suggests a lower IV compared to the past levels.
It’s key to look over IV rank when choosing the right options strategies. Keep in mind that traders’ ultimate goal should be to buy options when the IV is low and sell when the IV is high. When IV is low, the premiums are low-priced, providing the ideal conditions for traders to enter positions at a lower cost. Low-IV environments are great for using strategies like naked long calls/puts or debit spreads. On the other hand, traders should sell positions when IV is high because high volatility environments have higher stock prices and an increased demand for options.
Example
A good way to illustrate our point, let’s look at a trader who is selling credit spreads when the IV is high to take advantage of IV contractions. This trade involves selling an option and buying another option with a different strike price, all at the same time. As option prices are on the decline, short options are cheaper to buy back.
Focus on Liquidity and Bid-Ask Spreads
Tech stocks tend to be more liquid than the stocks of other companies in the options markets. Companies like Apple (AAPL), Tesla (TSLA), and Nvidia (NVDA) are large-cap companies, which means that they’re well-known and established. There is a consistently large number of shares traded daily by investors in their respective options markets, which makes them highly liquid, easy to buy and sell quickly.
Because stock options for companies like Apple, Nvidia, and Tesla are liquid, this has a big impact on their profitability and execution prices. High market liquidity leads to quick and efficient trade execution, and it can be done with limited impact on the stock’s price. This can ultimately lead to higher profitability. In contrast, low-liquidity stock options produce slower trading patterns, lower profitability, and possible price slippage.
If you’re trading tech stock options online, it’s best to stick to options with tight bid-ask spreads to minimize trading costs. A tight bid-ask spread indicates a small difference between the highest price that a buyer is willing to pay and the lowest price that a seller is willing to accept. It’s another sign of a liquid trading market when the bid-ask spreads are tight because it suggests an environment where trading is easy and quick. The closer these two prices are to one another, the better chance you have of keeping your trading costs lower.
Choose the Right Expiration Dates
When you’re facing the prospect of choosing a tech stock, an important consideration is choosing the right expiration date. Like any other kind of stock, tech stocks can come with either short-term or long-term expirations. Short-term options are better to use in volatile markets.
- The short-term options (60 days or less until the expiration date) will generally have higher premiums and higher risks within a volatile trading environment, but they can also be sold for a higher profit if the trader plays their cards right. These options are much more desirable to sell compared to the long-term options.
- The long-term options (several months or a year or more until the expiration date) carry less risk, and it costs much less money to enter these traders since the premiums are also lower. Long-term options are better used in stable markets and are representative of options contracts that are much more desirable to buy due to the lower cost to enter.
Trading weekly options is another choice that traders can make when it comes to tech stocks. These options are quite profitable as they’re able to capture quick market movements, and they’re effective for use in short-term strategies. However, weekly options carry a higher level of risk because they can incur heavy losses if the market moves against you, and there is the factor of rapid time decay working against you.
If you’re looking at a longer time horizon for your tech stock trades or investments, you might consider using LEAPS (long-term equity anticipation securities) for long-term plays. These are options contracts that have expiration dates that could be anywhere from one to three years away.
Master Risk Management with Defined Strategies
Traders should get into the habit of using stop-losses while trading tech stocks to limit their potential losses. Using these automated orders, traders can define the maximum amount they are willing to use. This sets up a floor for potential losses. Stop-losses are especially useful when trading tech stocks due to their volatile nature. Traders can stay on top of positions that are losing value by having them automatically sell off when they lose enough of their value.
Profit targets are an equally important tool for options traders who are dealing with tech stocks. These are automated orders that outline when a trader is willing to exit a trade for a profit. As the stock price goes up and reaches the profit target, the position will automatically be sold, locking in the profit for the trader.
Defined-risk strategies like spreads and iron condors work well for tech stocks because they’re market-neutral approaches that work well when traders are expecting range-bound movement or low volatility that comes from stable market conditions. Iron condors work especially well for tech stocks because tech stocks will exhibit periods of sideways movement or consolidation, and more expensive options as a result of high IV, which lets traders collect a premium when selling iron condors.
Use Spreads to Reduce Risk
Spreads are a strategy that offers a defined risk profile and reduces risk by limiting potential losses. This is achieved when traders are buying and selling options with different strike prices or expiration dates simultaneously. Let’s take a look at credit and debit spreads and how tech stock traders can use them to their advantage.
- Credit Spreads: This strategy is where traders buy and sell options of the same type (bull puts or bear calls) with the same expiration date but different strike prices. The result from this trade is a net premium credit, which is the difference between the premium received for selling the option and the premium paid for buying the options.
- Debit Spreads: This one is an options trading technique where the trader buys and sells options of the options of the same class (bull calls or bear puts) but with different strike prices. They’re best used for directional plays (bullish or bearish environments), and they offer the trader limited risk as well as limited reward.
Real-World Example
Let’s look at an example of the debit spread strategy when trading Apple (AAPL) options. For example, we’ll say that Apple is trading at $150 per share. The trader would need to buy one Apple call option with a strike price of $155 for $5 per share. This would result in a net debit of $500 for one contract. At the same time, the trade would also need to sell one Apple call option with a strike price of $180 at $2 per share. For one contract, this would result in a net credit of $200.
The net cost for this contract would be $300 (($500 – $200), while the maximum loss would be limited to the net debit paid which was $300.
Take Advantage of Sector Trends and News
Amazon is a leader in cloud computing, Tesla is a pioneer in AI technologies, and Nvidia is well-known for its developments with semiconductors. It’s key for traders to keep a close eye on sector trends or news from these major tech companies to correctly navigate when to buy and sell their stock.
When there are technological advancements and new product rollouts from tech companies, this can have a positive impact on stock prices. Because these tech companies play a large role in these technological developments, their stock prices have a tendency to rise, and there are a lot of people interested in trading these stock options, even if it costs more to take on these investments. They offer the promise of a good profit if the stock prices continue to rise.
It’s key to also monitor regulatory changes, antitrust cases, and government policies affecting these tech giants. Negative events such as these can cause the price of these stocks to go down and traders to go from buying patterns into selling patterns. Traders who sense that bad news is going to negatively affect the stock price can sell while the stock price is still relatively low.
Using tech sector ETFs like QQQ is a safer option for a lot of traders. They carry less risk because of diversification, and they have a higher return potential than going with individual tech stock options.
Consider Trading Index Options for Tech Exposure
Trading options on QQQ, XLK, or Nasdaq-100 futures (NQ) allows a trader to experience broader tech exposure, plus it comes with reduced company-specific risks. As a result, index options can reduce single-stock risk because a trader can hedge a diversified stock portfolio by buying put options on an index to protect against a market downturn.
Another great use of index options when trading tech stocks is that they can be used as a hedge, which can be expedient for traders during tech selloffs. Index options can protect an investor’s portfolio against potential market declines. Potential losses can be offset by traders who have the right to sell an index at a predetermined price.
Manage Theta Decay in Your Favor
Long calls and puts on tech stocks lose value quickly due to theta decay. To offset the negative effects of time decay, traders should use short-term spreads when trading tech stock options online. The best moves to pull this off are strategies like selling cash-secured puts or using covered calls for income.
- Cash-Secured Puts—This move is best used when you’re feeling bullish on a stock long-term, but you think it might decline in value in the short term. With cash-secured puts, theta decay works in the seller’s favor as the option prices decline as the expiration date draws near. It increases the likelihood of the put expiring as worthless and lets the trader keep the premium.
- Covered Calls—This strategy is used to sell call options on a stock you already own to effectively limit your losses and earn income in the form of a premium. As the time to expiration decreases, the value of the sold call option in a covered call trade also goes down in value. Theta decay increases the likelihood that the option will expire as worthless and that the trader can keep the premium as income.
Watch for Stock Splits and Corporate Events
There are a few other elements of trading tech stocks that are worth noting, like stock splits and other corporate events. Stock splits refer to a company increasing the number of shares outstanding by dividing the existing shares into more shares, which is a sign that a company is growing due to the demand from traders for more options. The opposite of a stock split is a buyback, which is where a company purchases its outstanding shares from the open market to reduce the number of shares available to traders.
How does stock splitting affect option prices? When companies like Apple, Tesla, and Google have split their stocks, this leads to more shares available, but their price per share goes down. However, it doesn’t change the shareholder’s stake or the overall market capitalization. It is a bullish signal to traders because it shows that the company is growing due to investor interest. It could be a good time to buy call options on these tech stocks.
On the other hand, buybacks can impact tech options pricing negatively because the company is reducing the number of shares available, a possible sign of contraction. If traders know ahead of time that buybacks are about to occur, they can adjust their strategy accordingly. The best course of action might be to buy put options on these stocks because there’s a good chance of the stock price going down.
Use a Trading Plan and Stick to It
Setting up clear entry and exit rules is one of the keys to forming a solid trading plan and sticking with it through the changing market conditions. It’s all rooted in the principle of buying low and selling high. To help you in this realm, it’s important to set up stop-loss orders and profit parameters that can keep you committed to your trading plan. Having your positions automatically sell once they’ve hit the maximum loss or profit you’re hoping to either incur or lock-in can help to minimize possible losses and to lock in the profit you’re looking for.
Keeping a trading journal to track successes and mistakes is another good practice to get into when trading tech stocks. When traders document everything they did while trading a tech stock, they can look over everything at the end of their trading session and figure out what they did well and what they could have done better. It’s a terrific tool for taking an objective look at your trading patterns and making future improvements.
Sticking to a trading plan is a good method to avoid big mistakes like emotional trading, especially in volatile markets. There’s no room for emotions like overconfidence, fear, or greed when you have a trading plan to execute. The plan can keep you in an objective and realistic state of mind where you’re using logic and reason to guide your decisions.
Final Thoughts: Mastering Tech Stock Options Trading
If you’re interested in trading options on tech stocks, keep our 12 key principles in mind as you go forward:
- Know that tech stocks can be highly volatile. Use strategies that profit from volatile conditions.
- Follow earning report announcements. Use long straddles or strangles for directional plays and short straddles or strangles for more range-bound markets.
- Monitor IV rank to determine entry and exit points for traders. Higher IV means higher prices and more active engagement, while lower IV represents declining stock prices and the chance to enter traders at a low cost.
- Focus on tech stocks with narrow bid-ask spreads.
- Choose the right expiration date that helps you lock in a profit or possibly benefit from theta decay.
- Practice good risk management techniques using strategies that have a defined risk profile.
- Reduce risks through using credit or debit spreads.
- Follow sector trends for additional opportunities.
- Trade index options as a good alternative to tech stocks for exposure with more limited risk.
- Take advantage of theta decay when you can.
- Keep an eye on stock splits or buybacks to inform your tech stock strategy.
- Remain consistent in your approach with a trading plan that has clear entry and exit rules, and keep a trading journal for future improvement.
As with any kind of options trading, remember to exercise volatility management, track liquidity, pay attention to earnings announcements, and use effective risk management techniques. Testing strategies in a paper trading account before using real capital is also super helpful when preparing to trade tech stocks.
Feel free to explore more options strategies on OptionsTrading.org – A Complete Guide to Successful Options Trading and sign up for free trading resources.
