• Stock Options

    Stock options trading is the preferred way to invest in the stock market by many investors. Since you don’t actually buy or sell the stock itself, only an option to buy or sell upon expiration, it represents a way to participate in the market without a large investment.

    It also represents a way to significantly reduce your risk while maximizing gains. So many traders shy away from anything to do with option trading, but there is nothing to fear about stock options trading; in fact, some might argue it’s better than trading the actual stock. You don’t need a large broker account and you don’t have to borrow any money to buy the stock itself.

    Advantages of Trading Stock Options

    If you’re like me, there are certain stocks that have always struck your fancy, but the cost of 100 shares was too steep and not possible to buy. But, for a much smaller amount you can buy an option on the same stock (equal to 100 shares). This is a way to be a viable investor and make some serious profits.

    If you own a stock, you actually own a piece of that business or corporation. An option is an agreement between a buyer and a seller. One party agrees to buy or sell to the other party at a predetermined price within a fixed time period. The stock options is a derivative of the stock and its price moves in the same ratio and direction as the stock. Many of the trades are made through the CBOE – Chicago Board of Options Exchange.

    Call Option

    A call option is buying the right (but not the obligation) to buy 100 shares of the underlying stock at a certain price (strike price). The option expires on the third Friday of the specific month of the option.

    When you bought the call option, you believed the price of the stock would go up, so if it does in fact rise in price, so does your call option (they move in the same direction and ratio). Therefore, your call option will be worth more than you paid for it and upon expiration you make a profit by either selling your option or you can actually buy 100 shares of the stock at the strike price which would be lower.

    Put Option

    A put option is buying the right (but not the obligation) to sell 100 shares of the underlying stock at a certain price (strike price). The option expires on the third Friday of the specific month of the option.

    When you bought the put option, you believed the price of the stock would go down, so if it does in fact decline in price, so does your put option (they move in the same direction and ratio). Therefore, your put option will be worth more than you paid for it and upon expiration you make a profit by either selling your put option at a higher price than you paid, or by actually selling the 100 shares of the underlying stock at the strike price at expiration, which would be higher.

    What is a Strike Price?

    The strike price is the price that moves the trade. When you look at an stock options chain (the listing of all the strike prices and the corresponding premium of the options) calls will be on the left and puts on the right. The prices will be listed in dollars, but that is just for 1/100 of the contract. The contract is 100 times the premium listed because it is sold in increments of 100. All of this can be viewed in streaming real time with broker-provided software.

    What is Expiration?

    The last day the stock option can be sold, bought, traded or exercised is called the expiration date. It is the third Friday of the month.

    In the Money — When the strike price is less than the price of the stock.

    At the Money – When the strike price is equal to the price of the stock.

    Out of the Money – When the strike price is greater than the price of the stock.

    How is Value Determined?

    When you buy or sell a stock option, (the right but not the obligation to buy or sell 100 shares of the underlying stock) the price of the agreed transaction is the “premium.”

    The longer the period of time from the original buy or sell of the option until the expiration, the higher the premium will be. This is called “time premium.” The difference between the stock price and the strike price is called the “intrinsic value.”
    The closer you get to expiration, and if the underlying stock price doesn’t change, the option value (both puts and calls) will decline. That loss is called the “decay.” Upon expiration, at the money and out of the money options will be worth nothing. As the expiration date moves closer, the faster the decay.

    Stock Options Trading Offers Big Opportunities

    Spreads and LEAPS are other ways to trade stock options, but the point I hope to make is that you can profit from trading in the stock market without risking huge sums of capital by buying the actual stock. It’s easy to get started, it’s a relatively straight-forward and simple method (of course, you need to do your homework), and you can profit in any market. There are people who make a comfortable living trading stock options and so can you.

    © 2011, www.daytraderoptions.com. All rights reserved.

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