Option Trading

Introduction

Option Trading is the trading of option contracts over an exchange. Trading options is an important aspect of market investments. It is a function of managing risk and generating income as well. It is also not restricted to individual stocks. But it can be considered more complicated than stock trading because option traders choose from variables besides the direction they believe the market or stock will move. Option trading can be very attractive for the small investors because it gives them the opportunity to trade very large amounts of shares while only spending a small amount of capital. This type of trading also helps the trader to purchase stock at a lower price and to benefit from a stock price’s rise or fall without owning the actual stock or selling it outright. The disadvantage of the option trading is that the number of optional stocks in the markets is really quite limited compared to the actual number company stocks that are traded. But the heavier a stock is traded the more likely options are traded too.

Options

When you trade in options, you are making a contract that gives you the right, but not the obligation, to purchase a block of stock at a given price at a future date. Trading options is a good way to cover yourself from major losses in the event you make a bad choice or call on a particular stock or investment. You can make just as much on the decrease of a stock's price as you can on the increase of a stock's price. Because you can leverage your money with options you have the potential to double or triple your investment. Each option has a buyer, called the holder, and a seller, known as the writer. There are two types of options, CALLS and PUTS. Call options give you the right to BUY shares in the underlying stock. Put options give you the right to SELL shares in the underlying stock. Call options increase in value when the underlying stock goes up. Put options increase in value when the underlying stock goes down. Options are quoted with a bid and an ask price. They can expire out of the money and become worthless. For the holder, the potential loss is limited to the price paid to acquire the option. For the writer, it is called selling Naked Call Options and selling Naked Put Options. Instead of buying put options, you sell short call options thereby pocketing the entire amount you made on selling the put options if the stock goes down. In the same way, instead of buying call options, you sell short put options thereby pocketing the entire amount of money you made on selling the put options if the stock goes up. But selling Naked options has unlimited loss potential which can lead to catastrophic losses. Only the very experienced option trader should expose himself to this type of trading.

Conclusion

Option trading is not necessarily for everyone, but then again, neither is cliff diving. The main reason that so many like option trading is that options provide the opportunity to turn a small or modest amount of money into a large amount of money quickly. It is a big money game, provided you play it right. The easiest way to start option trading is by opening an online option trading account with a broker, like Schwab Active Trader, which offers online option trading. You would then practice buying call or put options for stocks that you think will go up or down. Option trading is risky and you can lose all your money doing so. To be a successful option trader, you will definitely need a good sound strategy because there are many different trading strategies available for stock options. There are option trading books that will teach you what option trading is, what they can do, and the different strategies of option trading. The easiest way to learn about trading options is to go to the AvidTrader Library under the “Tools and Resources” menu and buy as many books as you can afford to buy on stock option trading. Because if you are truly serious about entering into the world of stock options you’ll need to spend some time learning how the successful traders play the game.