Lesson 7: 1.6: Choosing the Stock — Fundamentals and Technicals

• Fundamentals: Facts about the business itself, such as sales, profit and debt.

• Technicals: What the price chart is doing.

• Free cash flow: The cash a company has left after paying its bills and investing in the business.

• P/E ratio: The stock price divided by a year of earnings per share. It shows how many dollars you pay for each dollar the company earns.

• Moving average: The average price over the last 50 or 200 days. It smooths out daily noise.

• RSI: A 0 to 100 gauge of how hard the price has recently moved.

• Support: A price area where a stock has repeatedly stopped falling.

• Earnings report: The company’s quarterly results.

Every option is a bet on a stock, and the premium you collect or pay is the market's price for the risk in that stock. That creates a trap: the richest premiums sit on the shakiest stocks, because that is where the market sees the most risk. A beginner who sorts a screen by premium is, without knowing it, sorting for trouble.

So the first decision is never the strike or the date. It is the stock. Three questions, in order:

• Is it a good business? (Fundamentals)

• Is the price reasonable for what you get? (Valuation)

• What is the chart doing right now? (Technicals)

★ Core Fact: Fundamentals tell you whether you would want to own the stock. Technicals tell you whether now is a sensible time to act. Neither one predicts the future; together they keep you out of the worst trades.

You do not need an analyst's spreadsheet. Five readings cover most of what matters for an options trader:

• Revenue growth: Are sales rising year over year? A shrinking top line is a warning no matter how cheap the stock looks.

• Profitability and free cash flow: Does the company turn sales into real cash? Free cash flow that is positive and growing is the clearest sign of a healthy business.

• Debt: How much does it owe compared with what it owns? A common yardstick is debt-to-equity under about 1.5; much higher means a bad year can become a crisis.

• Earnings trend: Is earnings per share (EPS) rising? A one-off jump matters less than a steady climb.

• Valuation: What are you paying? Compare the P/E ratio (the price divided by a year of earnings per share) with the forward P/E (based on expected earnings). A forward P/E well below the trailing P/E means the market expects earnings to grow.

Worked example: Company A has revenue up 9%, positive and growing free cash flow, debt-to-equity of 0.6, and a forward P/E of 18. Company B has revenue down 4%, negative free cash flow, debt-to-equity of 2.8, and a forward P/E of 7. Company B looks cheaper and its options pay far more. It is also the one more likely to gap down on a bad quarter.

★ Core Fact: A cheap price is not a quality signal. Low valuation is only attractive when the business behind it is healthy.

Fundamentals say what the company is. The chart says what the market is doing with it right now. Three simple reads are enough to start:

• Trend: Moving averages smooth out daily noise. When the price sits above its 50-day and 200-day averages and those lines slope upward, the stock is in an uptrend. When it sits below falling averages, it is in a downtrend.

• Momentum: The RSI (Relative Strength Index) measures how hard the price has moved on a 0 to 100 scale. Above 70 is often called overbought, below 30 oversold. These are descriptions of a recent move, not buy or sell commands.

• Support: Prices where a stock has repeatedly stopped falling and bounced. A put sold below a well-tested support area has a floor of buyers underneath it. In Signal Desk these areas are called Strike Zones.

⚠️ Risk Warning: A stock that has fallen hard and shows an oversold RSI can keep falling. Selling a put into a falling stock only makes sense if you genuinely want the shares at that price, and not because the premium looks large.

A good stock on a good chart can still hand you a bad trade if something is about to happen. Check these before every trade:

• Earnings date: A company's report can move the stock 5 to 15 percent overnight. Premium is higher before earnings because of this, but a gap can carry the price past your strike with no chance to react. Know whether a report lands before your expiration.

• Recent news: A lawsuit, an investigation, a guidance cut or a merger announcement changes the picture faster than any indicator.

• Insider trades: Read them with care. Insiders sell routinely for taxes and diversification, so a few sales on their own tell you very little. Open-market purchases are far rarer and carry more information.

★ Practical Guidance: If an earnings report falls inside your trade window, treat it as a deliberate choice, not an accident. Many income traders simply pick an expiration before the report.

Put the pieces together as a short checklist you run before any option trade. If a line fails, skip the stock for now. There is always another setup next week.

• I would be glad to own this company for a year.

• Revenue is growing or stable, and free cash flow is positive.

• Debt is manageable and earnings are not collapsing.

• The price is not in free fall: it sits above, or is recovering toward, its 50-day average, or it is sitting at a tested support area.

• No earnings report or major event lands inside my trade window, unless that is my deliberate plan.

★ Core Fact: The checklist does not find winners. It removes the trades most likely to hurt you, and avoiding those is most of the edge in options income.

Choose two stocks: one large, familiar company, and one you have been tempted by only because its options pay a lot.

Open each one in Stock Research and run the checklist above using the radar, the fundamentals cards and the chart. Write down pass or fail on each line, then open the Grader for the same two tickers and compare its letter grade with your own verdict.

The gap between the two stocks, and how rich the second one's premium looked before you checked it, is the lesson. You already know how to read the option chain from Lesson 1.5; once a stock passes, Module 2 explains the Greeks, the numbers that show how an option will behave.