How much preparation is enough to trade stock options successfully? On the contrary, I am of the opinion that you may want to understand this incredibly versatile tool used in one form or another by major corporations, financial institutions and the largest wealth-management firms.
I recognize that options can carry higher risk than stocks. However, I believe all investments have inherent risk, and it is up to individual investors to make educated choices based on their own risk tolerance. What is a stock option? It is a contract that represents the right to buy or sell an underlying stock at a specific price on or before a certain date.
It is important to note that the option gives the buyer the right, but not the obligation, to buy or sell the stock as per the terms of the contract. Here are some of the basic terms in common use on the stock options market: Each contract represents an option to exercise for shares of stock. Premium prices are listed per share and must be multiplied by to obtain the price of one option contract, and;.
The first time I encountered the concept of stock options was when I came across a blog series detailing a daily options trading strategy. This strategy was particularly engaging to my analytical mind because it was based on technical trading. The premise appeared straightforward: Then, you sell your options and profit by the end of day.
I spent lots of time verifying the strategy and it seemed to check out. Even better, the strategy used a lot of the high-flying stocks that I was already familiar with trading. I also learned that I could use options to profit on speculation that a stock would drop. A short sale involves borrowing shares from a broker and immediately selling them on the market. To make a profit, the stock price must decrease, allowing the investor to buy them back at a lower price and return the shares to the broker.
Should the stock price increase, short-selling a stock presents a limitless loss of downside since a stock could potentially rise infinitely.
On the other hand, purchasing a put option would restrict my loss to the cost of the option. If you think a stock would increase, you could buy a call option. Why would one buy a call option instead of the stock itself, you might ask? Since call options cost a fraction of the price of the underlying stock, you stand to profit and also lose a lot more with this leverage. In fact, options can be used as a great hedging tool.
For example, if you own a stock but are worried about a downturn, you can purchase a put option for that stock. If the stock goes up as you had hoped, you will make a profit minus the small premium you paid for the put option.
However, if the stock goes down, your losses would be offset by the increase in value of the put option that you bought. This strategy is commonly known as a protective put. Obviously, I have only explained some of the basics. I would caution it is best to perform your own research and lots of it as your preparation for success.
Some brokerages offer virtual trading platforms, which I highly recommend using, to allow you to become familiar with the process and try out strategies before risking any of your hard-earned money. Syvia Poon is a financial analyst and an avid market observer with a particular interest in stock options trading.
She explains that beyond their use as speculative trading vehicles, stock options also have a function as hedging vehicles. She also recommends trying the virtual trading platforms or practice accounts available from some brokerages. Stock options explained To start off: Put option A short sale involves borrowing shares from a broker and immediately selling them on the market.
Call option If you think a stock would increase, you could buy a call option. Using stock options as a hedging tool In fact, options can be used as a great hedging tool.More...