Monday, December 17, 2012

Stock Market Options Trading 101

So you've found an investment and you're ready pull the trigger on it. Before hitting the buy/sell button, know that in the stock market, there are other financial trading instruments than stocks. There are the likes of bonds and options. This article focuses on stock market options trading.

What are Options?

Options are contracts that the trader has to buy or sell. Some people say that they are less risky than stocks. Instead of buy and sell, the two actions available to you are Call and Put.

Options are also known as derivatives because their value is derived from the underlying financial asset, which is usually a stock or a stock market index.

When to Call and When to Put? 
To call means to buy, and to put means to sell. When you think upon analysis of trends that the stock market will go down further the line below a price limit (or "strike price") within a particular set of time (or "expiry date"), you would want to exercise the contract by putting. On the other hand, if the strike price is at the minimum, the wise action recommended is to call. 

Every contract, however, has a corresponding expiration date. If you did not perform any transactions, the contract will just die on its own. It cannot be refunded. 

You may only exercise the call and put actions within the specified duration. Whether the stock market is going down, you can have profits when you make the right action. This is unlike buying and selling stocks, where your profits largely depends on the performance of the stocks.

The best timing is when your profit margin increases. However, the stock market might get reserved by the expiry date. If you're doing this options trading game online, you have to have a really trusted Internet service provider. Your connection puts you at risk. The worse thing that can happen is that you won't be able to cash in on your virtual profit.

Example of Options Trading to Improve Your Understanding

OK. After feeding you the fundamentals, let me give one example of an "options trading situation." Here are the given numbers:

Stock trading: $40
Possible amount of call option contract to buy: 10 stocks at $45, $2 per option
The cost price ----> Your investment based on this would be: $20, which came from 10 stocks x $2

YOU WIN if the stock price goes up to let's say... $50. The equation goes 10 stocks x ($50-45) = $50 minus $20 which is the cost price. Your total earnings would be $30, losing $20 with a 150% profit rate. This situation is led with the assumption that the stock price does not cross $45 before the expiration date of the option. If you are confident enough, in normal stock market trading, you would have to buy a lot more than this. 

If you bought the contract, in contrast, with $40 per option, the cost price would be $400 (10 stocks x $40). When you got a good call and sold it at $50 each, you can be a winner all the same. You gain $100 in the end, which is equivalent to 25% profit rate.

Conclusion

There are lots of resources and reading materials available online about options trading. Make sure that you are well prepared and have a grasp or really clear understanding of the stock market trends before going on trading. 

Options trading needs careful forecasts of stock prices in a particular time. Because of the market's volatility, you will be also required to stay updated on the stock market news. You can make big profits if only you bid on high risks with the right amount and right timing.