Options Trading Basics

New to Options? Want to trade option? This is the first step for you.

You many know many wealthy individuals make lots of money using options and you can try too.

Stock and Bond trading strategies run the gamut from the simple 'buy and hold forever' to the most advanced use of technical analysis. Options trading has a similar spectrum.

Options are a contract conferring the right to buy (a call option) or sell (a put option) some underlying instrument, such as a stock or bond, at a predetermined price (the strike price) on or before a preset date (the expiration date).

So-called 'American' options can be exercised anytime before expiration, 'European' options are exercised on the expiration date. Though the history of the terms may lie in geography, the association has been lost over time. American-style options are written for stocks and bonds. The European are often written on indexes.

Options officially expire on the Saturday after the third Friday of the contract's expiration month. Few brokers are available to the average investor on Saturday and the US exchanges are closed, making the effective expiration day the prior Friday.

With some basic terminology and mechanics out of the way, on to some basic strategies.

There are one of two choices made when selling any option. Since all have a set expiration date, the holder can keep the option until maturity or sell before then. (We'll consider American-style only, and for simplicity focus on stocks.)

A great many investors do in fact hold until maturity and then exercise the option to trade the underlying asset. Assume the buyer purchased a call option at $2 on a stock with a strike price of $25. (Typically, options contracts are on 100 share lots.) To purchase the stock the total investment is:

($2 + $25) x 100 = $2700 (Ignoring commissions.)

This strategy makes sense provided the market price is anything above $27.

But suppose the investor speculates that the price has peaked prior to the end of the life of the option. If the price has risen above $27 but looks to be on the way down without recovering, selling now is preferred.

Now suppose the market price is below the strike price, but the option is soon to expire or the price is likely to continue downward. Under these circumstances, it may be wise to sell before the price goes even lower in order to curtail further loss. The investor can, at least, minimize the loss by using it to offset capital gains taxes.

The final basic alternative is to simply let the contract expire. Unlike futures, there's no obligation to buy or sell the asset - only the right to do so. Depending on the premium, strike price and current market price it may represent a smaller loss to just 'eat the premium'.

Observe that options carry the usual uncertainties associated with stocks: prices can rise or fall by unknown amounts over unpredictable time frames. But, added to that is the fact that options have - like bonds - an expiration date.

One consequence of that fact is: as time passes, the price of the option itself can change (the contracts are traded just like stocks or bonds). How much they change is influenced by both the price of the underlying stock and the amount of time left on the option.

Selling the option, not the underlying asset, is one way to offset that premium loss or even profit.



Discover how to turn your investments into high monthly streams of income with less risk than most mutual funds with my free online ebook: MILLIONAIRE INCOME. Click this link to get it free: http://www.autopilot101.com/free/book_MI/index.htm

If you would like to discover how to double or triple your returns on your mutual fund investment and convert them into growing streams of monthly income, stop by the website listed below and get your free online ebook, "GROWTH & INCOME: How To BUild A Mutual Fund Money Machine": http://www.autopilot101.com/free/book_GI/index.htm

 

 
Translate Page Into German Translate Page Into French Translate Page Into Italian Translate Page Into Portuguese Translate Page Into Spanish Translate Page Into Japanese Translate Page Into Korean

More Articles

 

 

Search This Site

 

Related Products And FREE Videos





 

More Articles


How Risky Is Stocks And Other Relative Investments?

... business. Every business we do, no matter how small has its own risk. What is the major fear an investor faces? The major fright investors face is the fear of losing money. Each time you give investment a second thought, the next thing that may come to your mind is that you may be losing your money. Also, if the assets you invest in are held in another currency there is a risk that currency movements ... 

Read Full Article  


Intelligent Stock Trading

... kind there are various guides you can buy and it is a good idea to read several of these before spending any money. Penny Stocks: The Next American Gold Rush by Dan Holtzclaw Stock Investing for Dummies by Paul Mladjenovic The Guide for Penny Stock Investing by Donny Lowy These are all good and although they will not help you with specific decisions such as whether to buy a particular penny stock, or ... 

Read Full Article  


Investing In The Stock Market: How To Get Started

... have an average P/E ratio of 10. Whenever I evaluate a stock, I don't look at the P/E against all other companies, but I look at it against their competitors in the same sector. 3. Technical analysis and charts -- This is another tool that can help you see where a company has been, where the company stands now, and where it's headed in the future. It shows the company in a graphical form where you can ... 

Read Full Article  


A Disciplined And Organized Approach To Trading In The Stock Market

... consistent winner otherwise you will simply go broke faster.

Good record keeping
Although the process of gaining experience cannot be rushed, it can be made much more efficient by keeping good records of your actions. Good records will allow you to:

  • Review your actions at the end of each day to make sure you followed you strategy, not your emotions.
... 
Read Full Article  


A Trading Strategy That Consistently Beats All Major Indexes

... advantage. I do not trade in stocks. I do what I can to avoid individual stocks. And I consistently beat the market . . . month after month after month. If not stocks, what's the alternative? Like many people, I got heavily involved in the stock market in the mid to late Nineties. Tech stocks were going through the roof and I, like everybody else, wanted a part of the action. It seemed an easy way to ... 

Read Full Article