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Investing in Stock Options - What You Need to Know About Options

February 15, 2008

Stock options are important investments to consider when you are building wealth in the stock market. The most basic definition for a stock option is a contract that allows an investor to purchase or sell a specified stock at a specified price, within a specified amount of time. Employers commonly give stock options as asset based compensation, and investors buy and sell options on the stock market to gain capital. Every stock option is characterized by the name of the stock, the strike price, the option contract expiration date and the price that was paid for the contract.Basic Terms:

  • Call Options- these give the owner the right to buy a stock at a specified price, within a specified amount of time. Investors who buy call options are hoping that the stock value increases before the option expiration date.
  • Put Options- these give the owner the right to sell a stock at a specified price, within a specified amount of time. Investors who buy put options are hoping that the stock value decreases before the option expiration date.
  • Strike Price- the price that the option can be bought or sold at.
  • Options Investor Types: Buyers of Call Options, Sellers of Call Options, Buyers of Put Options, Sellers of Put Options

There is an important difference between the investors who buy and investors who sell options. Investors who buy puts and calls have the choice to exercise their option contracts. Investors who sell puts or calls have the obligation to exercise their options contracts. 

The price of a stock option must go above the strike price for investors to exercise and make a profit on call options and the price must go below the strike price for investors to make a profit on put options. When options fall into these ranges, they are called “in the money”. 

Options can be used for a wide range of trading scenarios, such as:

  • Reducing your risk from stock ownership
  • Generating an income from stock you already hold
  • Speculative trading in an up or down market
  • Multi leg option strategies to take advantage of specific market action
  • Volatility based strategies to take advantage of market volatility even if you do not know which way the market will go.

While is it true that options take some time to understand and to master, most people agree that once they have spent the time to properly educate themselves about options, that they are much better off for doing so. 

Many stock traders I know, once learning about options have never traded a single stock again. They can make more money, and take less risk by using a properly structured option strategy.

So if anyone is still on the fence, its definitely worth taking the time to learn about options.

Written by Brock Hamilton · Filed Under Option Trading 

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U.S. Government Required Disclaimer - Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the options markets. Don't trade with money you can't afford to lose. This website is neither a solicitation nor an offer to Buy/Sell options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this website. The past performance of any trading system or methodology is not necessarily indicative of future results.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.