The world of investment securities features many different financial instruments for the new investor. Treasurys such as T-bills and bonds are a common instrument, as are stocks issued by corporations that trade publicly. Treasurys are distinguished from stocks, though, because the former offer a guaranteed rate of return on investment while stocks offer no guarantees of return or profit whatsoever. Smart stock investors, however, can employ a number of strategies to lessen their risk, including different methods for engaging in stock options trading.
Basically, stock options give you a right to sell or purchase securities at preset prices within a certain amount of time, though you have no obligation to do so. Buyers of call option contracts gain the right to purchase a predetermined amount of shares or other securities, called underlying assets, at an agreed-upon price, which is called the security's strike price. When you buy a call option contract from the trader writing it you'll have up until the contract's expiration date, or its expiry, to make your purchase. It's important when engaging in stock options trading to obtain a favorable strike price on options contracts because your potential profit will be greater when you do.
Call option and put option contracts are big business on the securities markets. Put options give their buyers rights to sell the underlying assets in those contracts at previously agreed-upon strike prices. Put options are the opposite of call options, because in a put the purchaser believes the sale price of the securities in the contract will be greater than their purchase price by the time the contract's expiry rolls around. When you decide not to exercise your call or put option contract rights you lose all rights as well as any obligations to buy or sell the shares in that contract. However, traders not exercising rights in call options or put options really only lose the money they paid for those rights, which is usually less than the collective worth of the securities making up those contracts.
In stock options trading, a call option is an option to buy the security in question at a price you think will be lower than what its price will be when the purchase option comes due or reaches its expiration date. Options contracts themselves are usually priced in 100-share blocks. For example, a 100-share call option may be priced at $50, meaning the call option purchaser will pay the contract option's writer a fee or premium of .50 per share or $50 (.50x100 = $50) for the right to buy each of those shares at a predetermined price by the contract's expiry.
Here's a basic example of a stock option transaction: you purchase a 100-share call option for $50 at $10 per share, expecting the stock's price to increase to $15 per share by contract expiry. At the end of your option contract's term the stock has risen to $15 per share and you pay $1,000 to buy the stock ($10x100 = $1,000) while quickly selling it for $1,500 ($15x100 = $1,500) and a 50% profit. Before you engage in any sort of stock options trading, though, understand thoroughly just how to exercise the rights inherent in call as well as put option contracts. Really, though, all a call or put option contract is, is just one more way to buy a stock at a low price and then sell it at a higher price.
Stock options trading can be a bit more complicated than buy stocks at one price and later selling them at another. There's a major benefit to be found in stock options trading, however, and it's that if you trade options smartly you can limit your potential loss, known as "downside," as well as increase your hoped-for profit, or "upside." Remember; you're really not obligated to sell or buy the underlying securities that make up a stock option contract. All you typically lose in call or put option contracts when you don't exercise their options is the fee or premium you paid to the traders or writers of those contracts, such premiums giving you the right to buy or sell those shares.
Rookie options traders tend to make one common mistake when first starting out, and it lies in the fact that some take too many risks before they really understand stock options trading. Investors just getting into options trading should make an effort to thoroughly understand what an uncovered or "naked" option is, for example, because ending up holding too many of them can be financially ruinous. Options traders may find themselves in what are called "naked positions," which result when those traders end up writing contracts for options when they don't actually own any of the stocks or securities being sold or bought by their purchasers.
Writing an option contract giving a purchaser the right to buy or sell stock you don't really own in that contract is risky business, though it can be lucrative. Most brokerage houses, though, don't allow new or inexperienced investors to place naked or uncovered option contract orders. New investors entering the stock options trading world should take small, easily handled steps such as basic call or put option contracts, which can also be highly profitable, before they dive into the deep end of the options pool, so to speak. In reality, before you even engage in the business of trading in stock options you should first spend time learning from far more experienced traders willing to share the ins-and-out of stock options.
Basically, stock options give you a right to sell or purchase securities at preset prices within a certain amount of time, though you have no obligation to do so. Buyers of call option contracts gain the right to purchase a predetermined amount of shares or other securities, called underlying assets, at an agreed-upon price, which is called the security's strike price. When you buy a call option contract from the trader writing it you'll have up until the contract's expiration date, or its expiry, to make your purchase. It's important when engaging in stock options trading to obtain a favorable strike price on options contracts because your potential profit will be greater when you do.
Call option and put option contracts are big business on the securities markets. Put options give their buyers rights to sell the underlying assets in those contracts at previously agreed-upon strike prices. Put options are the opposite of call options, because in a put the purchaser believes the sale price of the securities in the contract will be greater than their purchase price by the time the contract's expiry rolls around. When you decide not to exercise your call or put option contract rights you lose all rights as well as any obligations to buy or sell the shares in that contract. However, traders not exercising rights in call options or put options really only lose the money they paid for those rights, which is usually less than the collective worth of the securities making up those contracts.
In stock options trading, a call option is an option to buy the security in question at a price you think will be lower than what its price will be when the purchase option comes due or reaches its expiration date. Options contracts themselves are usually priced in 100-share blocks. For example, a 100-share call option may be priced at $50, meaning the call option purchaser will pay the contract option's writer a fee or premium of .50 per share or $50 (.50x100 = $50) for the right to buy each of those shares at a predetermined price by the contract's expiry.
Here's a basic example of a stock option transaction: you purchase a 100-share call option for $50 at $10 per share, expecting the stock's price to increase to $15 per share by contract expiry. At the end of your option contract's term the stock has risen to $15 per share and you pay $1,000 to buy the stock ($10x100 = $1,000) while quickly selling it for $1,500 ($15x100 = $1,500) and a 50% profit. Before you engage in any sort of stock options trading, though, understand thoroughly just how to exercise the rights inherent in call as well as put option contracts. Really, though, all a call or put option contract is, is just one more way to buy a stock at a low price and then sell it at a higher price.
Stock options trading can be a bit more complicated than buy stocks at one price and later selling them at another. There's a major benefit to be found in stock options trading, however, and it's that if you trade options smartly you can limit your potential loss, known as "downside," as well as increase your hoped-for profit, or "upside." Remember; you're really not obligated to sell or buy the underlying securities that make up a stock option contract. All you typically lose in call or put option contracts when you don't exercise their options is the fee or premium you paid to the traders or writers of those contracts, such premiums giving you the right to buy or sell those shares.
Rookie options traders tend to make one common mistake when first starting out, and it lies in the fact that some take too many risks before they really understand stock options trading. Investors just getting into options trading should make an effort to thoroughly understand what an uncovered or "naked" option is, for example, because ending up holding too many of them can be financially ruinous. Options traders may find themselves in what are called "naked positions," which result when those traders end up writing contracts for options when they don't actually own any of the stocks or securities being sold or bought by their purchasers.
Writing an option contract giving a purchaser the right to buy or sell stock you don't really own in that contract is risky business, though it can be lucrative. Most brokerage houses, though, don't allow new or inexperienced investors to place naked or uncovered option contract orders. New investors entering the stock options trading world should take small, easily handled steps such as basic call or put option contracts, which can also be highly profitable, before they dive into the deep end of the options pool, so to speak. In reality, before you even engage in the business of trading in stock options you should first spend time learning from far more experienced traders willing to share the ins-and-out of stock options.
About the Author:
Before you even think about taking out a stock option make sure you stop by Option Millionaires at stock options trading for the best in option trading tutorials and training.. Unique version for reprint here: Basic Stock Options Trading: How Call Option And Put Option Contracts Work.
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