Trading stock options is the process where options on stock are traded instead of the stock itself. When you purchase or sell a stock, you are buying or selling an actual part of the ownership in that company. A stock option is a contract between two individuals or businesses. Stock options are another kind of security that can be bought, sold, or traded. These securities offer great versatility, and a trader can adapt their position according to the situation. Stock options can be made as conservative or as speculative as you want to make them. Stock options are a very complex security, and there is always the risk of a loss of capital no matter who tells you differently.
A stock option is simply a contract that gives a buyer a right to purchase or sell an underlying asset at a fixed price before a set date, but does not create an obligation for the buyer. A stock option costs you a price, and for that price you get the option to purchase or sell the asset if you decide to. If you purchase a stock option at a specific price and the price rises dramatically, you purchase the stock at the agreed upon option price, and you make the profit from the increased market price. A stock option can make a substantial amount of money for a trader if everything goes the right way.
Stock option trading can also have a number of risks involved, and the stock option market is speculative. The best advice is to only invest risk capital into the stock option market, and never place money you can not afford to lose. The two types of options are call and put options. A call option gives the option holder the right to buy the asset before a certain time. A put option gives the option holder the right to sell at a specific price before a specified date.
The rewards to trading stock options can be significant, but so can the risks involved. Money is made and lost every day on this market, so it is important to only use risk capital on the stock options market. By learning everything you can about stock options trading, you can minimize the risk while maximizing the profits from trading stock options. By knowing about the stock option market and what it consists of, you will increase your trading options and help to minimize your losses.
Copyright ? 2007 Joel Teo. All rights reserved.
Many people believe that the stock market can make you rich one day, but also make you bankrupt the next. Well, how eould you like to know about a method of stock trading that completely saves you from unlimited loss, but still leaves the door open for unlimited profit? That method is buying and selling stock options. How to trade stock options would best be explained using the following example.
Lets say a person who thought that a stock selling in the market at 50 would decline to possibly 30, that person could buy a Put stock option. Not, however, that in buying a stock options, one should have some idea to what extent the stock might move.
In inquiring what a Put stock option would cost, the person might receive a nominal quote of, say, $350 for a Put at the market for 90 days. Most options are negotiated "at the market," which means at "the current market," when the option can be obtained by the option-dealer.
Suppose that the stock is selling at 50 and the quoted price of $350 is satisfactory to you. You enter your order: "Buy a 90-day Put on 100 XYZ [the name of the stock] for $350." If you are trading through your stock-exchange broker, the broker will give your order to an option-dealer who will contact one of their clients who sells options on that stock and will attempt to buy the option for you.
When, after this contact or several others, the dealer has obtained the Put option for you, the dealer reports to the stock-exchange broker who gave him the order, and the broker in turn reports to the customer: "Bought Put 100 XYZ at 50 expires December 30 for $350." Let us say that the person who bought the Put option, expecting a decline in the stock, was wrong, and that the stock, instead of going to 30 (as expected), advanced to 70 and was selling when his option expired. The person would have lost the $350 that they paid for the Put option.
Bear in mind that the limit of the person's loss was the cost of the Put option, or $350, no matter how high the stock rose and no matter how wrong the person was, and that the person would draw on the equity in the account to that extent only. Suppose, on the other hand, the person had sold the stock short in the market. The loss would have been 20 points and still no knowledge as to the possible extent of loss until the person covered the short sale. But in the purchase of the Put option the account would read:
Bought Put on XYZ at 50 for 90 days: Loss $350
Remember, too, that no trade has been made in the stock, so no stock-exchange commission has been paid. A regular stock-exchange commission is charged by your broker only if a transfer of stock is made in connection with the option.
On the other hand, suppose the person's judgment was correct and the stock declined to 30. If the person had instructed the stockbroker to buy 100 shares at 30 and exercise the Put option, the account would look like this:
Sold 100 shares at 50 (through exercise of Put) $5,000
Total Receipts $5,000
Bought 100 shares in market at 30 3,000
Bought Put at 50
Cost 350
Total Cost 3,350
Profit on trade $1,650
The profit then would be almost 500 percent of the cost of the Put contract. The profit is the difference between the cost of the stock plus the cost of the Put option and the proceeds of the Put that was exercised.
In all of these examples showing the use of options, the commission cost has been ignored. But at no time could the loss have been more than the cost of the option - $350 - and any stock-exchange commissions would have been paid out of profit or out of possible recovery of part of the premium which was paid.
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