Option Trading Strategy

Options Trading Made Easy - Learn How To Profit

If you're trading stocks or bonds, there are a whole range of strategies you can follow, which range from the long term buy and hold, right through to day trading using technical analysis. Options trading is very similar.

Understanding exactly what an option is one of the trickiest things to understand when you're starting out. Basically, an option is a contract that gives you the right to buy (a call option) or sell (a put option) a stock or bond at a set price (the strike price) on or prior to a set date (the expiration date). You might need to read that a few times to get the hang of it!

There are different types of options available in the marketplace, with 'American' options able to be exercised anytime between purchase and expiration, and 'European' options only able to be exercised on the expiry date. Although the terms are geographical, nowadays the location where you buy options doesn't automatically mean you've bought one type or the other. As a general rule of them, American-style options are mostly used for stocks and bonds, whereas European-style options are for indexes.

Officially, options expire on the Saturday after the third Friday of the expiry month of the contract. However as US markets are shut on Saturdays, that makes the Friday the effective expiry day. Talk about confusing!

Now that you have a basic understanding of what an option is and how it works, let's take a look at some basic strategies. I'll just focus on American-style options for stocks.

When you buy or sell an option, you basically have two choices - you can hold it to maturity, or you can choose to exercise it prior to expiry. A large proportion of investors do hold their options until maturity before exercising it to trade the underlying asset. Let's look at an example.

You've purchased a call option for $1, with a strike price of $25. As options contracts are generally for 100 share lots, your purchase (ignoring commissions) would cost you $100, and you'd have the right to purchase $2500 of stock through the option. Now, if the expiry date arrives and the stock is worth $27, it makes sense to go ahead of buy the stock, because you only have to pay $25. That means you've made an immediate profit of $2 per share if you sell them again immediately on the stock market. However you still have to factor in what you paid to buy the option, which was $1 a share. So after your purchase costs are deducted, your overall profit is $1 a share. Well done!

But what happens if the share price doesn't hit $27 - or even $26, which is your breakeven point for this option. Well, if there is still time to expiry and the share price is above $26 but appears to be dropping, it may be a good idea to exercise the option immediately so you can get out of the contract without loss. If the share price is under $26, you might still be able to sell the options for a smaller amount than you paid, for example 20c a share, and recoup some of your losses. If the option is now worthless, you basically just let the contract run in the hope that the price might jump up again, but accept that you've lost your $100. One of the good things about options is that you've only bought the option to purchase or sell - you're not under any obligation to do either upon expiry. So your risk is limited to the amount you spend buying the option in the beginning.

One thing to be aware of is that option prices aren't just influenced by the price movements of the underlying assets - they're also affected by their time to expiry. As the expiry date approaches, option prices tend to drop rapidly. So if you have an option that you don't want to hold until expiry, it may be worth selling out early to avoid being too badly hurt by the price dropping as expiry approaches.

Timothy Gorman is a successful Webmaster and publisher of Online Stock Trading Secrets. He provides more stock advice, information and ways to make money with options trading that you can research in your pajamas on his website. Article Source: http://EzineArticles.com/?expert=Tim_Gorman

What Is Options Trading?

If you've been trading stocks for a while and want to do something a little more speculative, then maybe options trading is for you. At a very basic level, an option traded on the stock exchange means 'a right'. So an options trade involves giving someone the right to buy or sell a certain stock at a certain price by a specific time. If you buy an option to purchase securities, then it's called a call option. If the option you buy is to sell securities, then it's referred to as a put option. Some traders even go so far as to purchase both calls and puts on the same stock, with agreed prices and by an agreed date, then it can be called a double option, or sometimes a put and call option.

Confused yet? The hardest part of options trading is understanding all the jargon. But once you understand all the technical names for various instruments, you'll soon discover that what you really need to know is which way you think the stock price is going to move in the near future. That's it. Once you have an idea what's going to happen, then all you need to do is use the right option trade to benefit. For example, if you expect a stock's price is about to rise, then you would purchase a call option on that stock. This would enable you to buy now at a lower price, and sell in the future at a higher price. This trade works if the stock's price rises, but if it doesn't, you could be left holding a bunch of worthless options. When it comes to put options, it works the opposite way - you buy put options if you think the stock's price is going to fall. In both cases, you secure your right or option by paying a premium to the person selling the option.

The premium you pay is known as the option money. If the market moves against you, then the only money you will lose is the option money you've paid. So the good thing in options trading is that your losses always have a known ceiling. So if you don't want to risk large amounts of capital, but still want to use a smaller amount of money to gain from price variations, options trading can be the answer. The bottom line, though, is that options trading is something that you should only dabble in once you've spent time learning about the stock market, and if you are confident that you can make decisions calmly when the pressure is on.

If you want to learn more about trading options, click over to David's site at http://www.tradingoptionsplus.com Article Source: http://EzineArticles.com/?expert=David_Jacobsen