An option is a contract giving to a buyer the right, but not obligation to buy the underlying asset at a specific price on or before a certain date.
Options will be exercised by either a call which is a buy or a sell which is a put. As a beginner trader options can be very risky, however, when used properly and prudently they are actually safer than other investments.
We will provide a basic understanding and core concepts how options work from an expert’s view.
Options are again contracts that allow you to buy or sell something, that can lead to profit without owning that asset. By buying option contracts you invest less money than owning the original asset or stock.
Options are bought based on a strike price and can only be bought in 100 shares increments. A strike price of an option is a fixed price at which the owner of the option can buy, or sell, the underlying security and commodity.
Most investors buy options on speculation that a stock is going to go up (call) or down (put).
Here a scenario of a company just about to report earnings. If you bought the option at $2.00 strike price at 100 shares per contract with a company stock price of $50.00 you would just pay $200.00 per contract. If you buy 3 contracts than your total cost for the 3 contracts would be $600.00.
Let’s say the company’s earnings did well and the stock price went to $75.00. You would have made a profit of $25.00 per contract, times 100 shares equal $2,500.00 per contract. But you have bought 3 contacts, so your profit would be 7,500 minus the $600.00 that you paid for all 3 contracts. So, your profit would have been $6,900.00.
Let us say you bought the 300 shares on the exchange. Your cost would have been $15,000 And the shares went up to $75.00 from $50.00 your profit would have been $7,500.00. The same profit as the option contract minus the $600.00.
Just think if you bought the stock on the open market for $15,000 and the stock went down a couple of points you would be in a losing position and not sure if the stock is going to go down further or if the stock is going to rally.
With the option trading you will always know exactly what your fix lost would be. For example, in this scenario the fix lost would have been $600.00.
The key factors in choosing an option is the strike price and option time curriculum. Options contracts have an expiration date. These dates can be weekly, monthly, quarterly, semi-yearly, yearly, and out even further.
Depending on where the stock price is at the expiration date, determines if you lose money or make a profit.
However, you can execute a trade and get out of your option at any time. Ok course, if you play a call you are betting the stock will go up and if you play a put you are betting the stock is going down. Strike price and expiration date is the key to trading options.
Here are some names of core concepts if you decided to get into option trading. Covered Calls, Long/Short Call & Put, Protective Put, Vertical Spread, Calendar Spread, Diagonal Spreads, Butterfly, Straddles and Strangles and Collars.
Of all the core concepts the Covered Call is the safest concept to execute.
For more information on understanding risk you can go to www.DiverseInvesting.com or purchase The Road Map to Investing on Amazon.
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