Trading Stock Options

Trading stock options is a great way to maximize your gains, while minimizing losses. I want you to know now what it took me a long time to learn – you can participate in the stock market without actually having to buy a stock. You can trade stock options without a large trading account, and you don’t have to borrow the money to buy the stocks. Success is definitely possible and risk is substantially lowered. There are of course, many facets to trading stock options and we’re going to discuss a few.

STOCK OPTION TRADING MIGHT JUST BE YOUR TICKET TO SUCCESS

At first, trading stock options seemed complicated. I didn’t know the difference between a call and a put or a strike price or a strike out (which is what I was most used to), but it’s not really all that complex. There are certain stocks that we all like, follow, and in fact want to own, but we never have enough investment capital to get in the game. When I found out about the small amount required to buy an option on the same stock I was interested in, I knew immediately that this was a great way for me to participate in the market. I remember when I bought my first option. It was the summer of 2001 and I made $250 on 3 Coca-Cola calls. I was a happy camper that day; not necessarily over the $250, but a door had opened for me to finally make some profits in the stock market. I went on through that door and continued my success.

Trading Stock Options The Best Way

STOCK OPTIONS

A stock option is literally a contract between two traders. It’s yet another vehicle to trade the market. If you own a stock, you actually own a piece of that company. An option is an agreement in which one party agrees to buy or sell to the other party at a specified price within a predetermined period of time. The movement of the price of the option (the derivative) is in the same direction and ratio as that of the underlying stock price. Trading is held on various exchanges such as the Chicago Board of Options Exchange (CBOE) or the Philadelphia Stock Exchange.

Call Options

When you buy a call option you are buying the right (but not the obligation) to buy 100 shares of a company’s stock at a certain price. That price is called the strike price. You can hold that option until the third Friday of the specific month of your option, which is the expiration date. The beauty is you don’t have to buy 100 shares of the stock itself.

When you purchase a call option you believe the stock will go up and therefore your call option will be worth more than you paid for it. At expiration, you make a profit by either selling your call option at a higher price than you paid, or by actually buying the 100 shares of the underlying stock at the strike price, which would be lower.

Put Options

When you buy a put option you are buying the right (but not the obligation) to sell 100 shares of a company’s stock at a certain price. That price is called the strike price. You can hold that option until the third Friday of the specific month of your option, which is the expiration date. The beauty is you don’t have to buy 100 shares of the stock itself.

When you purchase a put option you believe the stock will go down and therefore your put option will be worth more than you paid for it. At 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.

EXPIRATION, STRIKE PRICE, OPTION CHAIN

Expiration is the last day the stock option can be sold, bought, traded, or exercised. Once expiration is over, the option is worthless. The strike price is the price that moves the trade.

Advantages of Trading Stock Options

When you look at an option chain the prices of the calls will be on the left and the puts on the right. The prices will be in dollar amounts, but because you have to buy the options in increments of 100 the price you will have to pay is 100 times the amount listed on the chain. There is an abundance of resources to watch streaming real time option chains. Many brokers supply that in their trading software.

IN, AT AND OUT OF THE MONEY

When the strike price is less than the price of the stock it is “in the money.”

When the strike price is equal to the price of the stock it is “at the money.”

When the strike price is more than the price of the stock it is “out of the money.”

PREMIUM, INTRINSIC VALUE, DECAY

The premium is the price of a call option that a buyer pays for the right (but not the obligation) to buy 100 shares of the underlying stock. The buyer does not have to pony up the price that the actual stock would cost. The greater the time between the point of buying the option and the expiration, the greater the time premium. The time element and the intrinsic value of the option make up the entire option premium.

Intrinsic value is the difference between the price of the stock and the strike price. More value of the option price is called the time premium. If the May 2011 40 call option is being sold for $7 while the stock is trading at $45, then the intrinsic value is $5 and the time premium is $2.

As the expiration date approaches, if the price of the underlying stock does not change, the value of both calls and puts goes down. That amount is called the decay. When expiration arrives, the at the money and the out of the money call options have no value left. The speed of decay accelerates the closer you get to expiration.

SPREADS

When you buy a stock option at a particular strike price and you sell another stock option of the same underlying stock, it is called a “spread.” If you have bought a call option you can sell another call option so long as the strike price is greater than or equal to the option you already own and the date of expiration is less than or equal to the option you already own. While trading spreads does mean sacrificing potential gains, it’s another way to reduce your risk when trading stock options.

LEAPS

Leaps are just long term stock options. LEAPS stands for “Long term equity anticipation securities.” Leaps can be either puts or calls. They usually begin about 2.5 years out. Once the time till expiration is less than 6 months, they are no longer considered LEAPS. LEAPS have different expiration dates and provide certain tax advantages.

START STOCK OPTIONS TRADING NOW

You can profit in any market. A volatile market can really give you an advantage and it is indeed possible to make a nice income trading stock options. When the market goes down, you can profit. Look what happened in fall of 2008. When it was obvious that stocks were going to take some major hits, put option premiums shot up. A $3000 investment would easily have made over $2000 in less than a week.

While trading stock options I have found buying call options attractive because it’s a good way for me to leverage my money. When I feel the market is beginning to advance, I need a way of participating without buying 100 shares of a stock.  Of course, there is no such thing as no risk investing, but stock option trading is an avenue you need to explore.

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