Having been a student of the stock and option markets for 17 years and seeing new traders enter the market each year seeking there fortune only to see them wind up broke and bitter a year later I find myself wondering why this is with all the advances in trading. At the beginning of the 21st century I see more computer models, sof... Read more
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Trading stock options as an investment tool is an often misunderstood trading concept by both traders and investors yet, once understood, can be very powerful and flexible tool in your investment choices. Consequently, as a result of there potential for profit and flexibility they are often view by many in the investment community as too complex to implement effectively. However, if a few basic concepts of stock options are understood such as types of options offered, leverage, risk control, time, and strike prices then beginning traders and investors can avoid common misconceptions of this powerful investment alternative.
There are two types of options that are offered on publicly traded shares - "calls" and "puts". When you believe that the stock of a company is going to rally and rise in price then you want to invest in call options as they appreciate in value on an upward move. If you believe that a stock is going to fall and depreciate in price then you want to invest in put options as they appreciate in value. Calls, then, have a upward directional bias and put options have a downward directional bias. The second factor to understanding stock options is that they offer one of highest sources of leverage by allowing you to control blocks of 100 shares per each option. For example, if you bought 100 shares of a $60 stock then you would have $6,000 invested but you would only need a few hundred dollars to control the same position with options. If your $6,000 worth of stock rose from a share price of $60 to $72 and you sold then you would realize a gain of 20% or $1,200. But if you owned call options on the same position you could conceivable earn a 200% or 300% gain! Now, if you are starting to realize how powerful stock options are by offering you this kind of leverage then you will understand after reading the next few sentences that there potential for risk control is unparalleled! You see, when you purchase an option on a particular stock whatever the cost of the option is the only portion you actually risk. For example, if you buy a call option on a $60 stock that you believe is going higher and then the next day the CEO for that company announces the company's bankruptcy which results in the stock falling to zero the most you can lose in that scenario is $300. Whereas if you owned 100 shares at $60 a piece or a $6000 you could lose then entire $6000! Stock options offer you an enormous advantage in profiting from the markets you must understand the concept of time in how it applies to option trading. Though they vary a bit, stocks offer different types of options with different time periods on them. These time periods, or what is commonly referred to as expiration periods, range from 30 days out to as long as 3 years with expiration days occurring every third Friday of calendar month. In my opinion, it is vital for you to understand the average holding days for your option trades so that you purchase the proper option so that it has enough time on it so you have time to profit from you position. If the average holding period is seven days and it is the middle of the month then purchase the next month's options so that you have 2 weeks plus another month in order to give your option position enough time to profit. Any option under 30 days till expiration is rapidly disintegrating in value due to time decay. The other critical concept you must understand when trading options is what strike prices are and how to use them. "Strikes" are the set price terms assigned to a given underlying instrument or, in this case, to the stock of a publicly traded company. As an example, XYZ company's stock is at $70 a share and its call options are listed at a $65 strike, $70 strike, and $75 strike. Each strike has its advantages depending on your option trading method but knowing what strike prices are offered and understanding them in relation to option trading will help you make the best trading decision on which stock option to select. By learning to implement stock options into your investment choices you can add their enormous potential for high profits and risk control to your trading arsenal. By taking some time to reread this article as well as similar material you can begin to see how they can help you profit in almost any market. Whether the market is rising, falling, is range bound, or you are just trying to protect your stock portfolio from market volatility by taking advantage of the power and risk control of stock options you can take advantage of almost every opportunity in the market.
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