With stocks, you own a small piece of a company.  However, with options, you purchase the right to buy or sell underlying stock.  There are two basic types of options – calls and puts.  When you purchase a call option, you buy the right to purchase a stock at a specific price before a specific date.  When purchasing put options, you buy the right to sell a stock at a specific price before a specific date.  Like stocks, you can both buy and sell options. 

Traders consider buying call options when they are bullish on an underlying stock.  As the stock rises, call options, in general, also rise.  There are, though, some important differences between buying an underlying stock and its call options.  First, options are cheaper than buying the underlying stock.  If you a share of XYZ is $100, it may cost you the same to control 1000 shares with options.

Options are cheaper because they have a strike price and an expiration date.  The strike price of a call option is the price at which you have the right to purchase the stock.  If the price of an underlying stock is above the strike price, the call option is considered “in-the-money.”  If the price of the stock is below the strike price, the call option is “out-of-the-money” while it is “at-the-money” if the stock is the same price as the strike price.  Call options that are in-the-money have inherent value.  For example, let’s say the price of stock XYZ increased to $105.  You, however, own a call option with a strike price of $100.  You thus have the option to buy XYZ at $100 while selling it for $105.  This in-the-money call option thus as an inherent value of $5.  Call options that are at-the-money do not have any inherent value.  For instance, it would not be worth it to exercise a call option with a strike price of $15 because you cannot sell it for a profit.  Call options that are out-of-the-money actually have a negative inherent value since the stock would have to rise just to get to the strike price.  The farther the stock price is from the strike price, the lower the inherent value. 

The expiration date is the time until which you have to exercise your option.  Because options expire, they have a time value.  As the expiration draws nearer, the time value of call options decrease because there is less time for the underlying stock to increase in value.  A call option that expires in a year will therefore have much greater time value than a call option that expires in a week.  The price of options are roughly calculated by:

                  Option price = inherent value + time value

There are several exit strategies with call options.  If you do nothing and let an option expire, call options that are at-the-money or out-of-the-money will become worthless – they will have no inherent or time value.  However, if a call option is in-the-money at expiration, you can exercise your option for a profit.  Many option trading companies will automatically exercise options that are in-the-money at expiration for you. 

Most option traders, however, have no intention of ever owning the underlying stock.  Traders often sell their options well before expiration.  Call options, in general, increase in value with the underlying stock.  Thus, if a stock rises, you can usually sell a corresponding call option at a profit. 

This can be beneficial because it leverages your capital.  Let’s say you have $1000 to invest.  If a share of XYZ costs $100, you can buy 10 shares.  However, a call option of XYZ, with a strike price of $100, costs only $10.  You can thus alternatively purchase 100 call options of XYZ.  If shares of XYZ go to $105 at expiration, owning the stock would give you a profit of $50.  Owning the options, however, would give you a profit of roughly $500.  The risk in call options, however, is that this increase in price needs to occur before the expiration date. 

For more information about trading options, visit DayTradingModels.com

1. The stock’s past history and movement.

2. Expected earnings reports of the stock’s parent company.

3. Volatility and volume of shares traded daily.

4. Any current news concerning the company’s growth or profitability.

5. The price of the option with respect to how you think the stock will perform. If you do not feel the stock’s movement will handily offset the cost of the option, plus the trading fees, then buying or selling the option would be fruitless.

6. Supply and demand of the underlying stock. (Industry group market action.)

Once you have decided upon which stock to pick, you next need to decide whether you believe the stock’s price is likely to rise or fall. (With stock options you can make money in either direction.)

By purchasing a Call option:

1. You expect the price of the underlying stock to rise, so you can then purchase it at the lower strike price, making a profit in the transaction.

2. You have the right to control 100 shares of stock for a fraction of the cost of purchasing the stock outright.

3. You are managing your risk by limiting the downside to the premium paid for the option. The major downside to buying any option is time decay. Your option expires within a finite period of time. If the underlying stock price behaves as expected, you will not need to be concerned about execution.

Having shown you the benefits of buying Calls over the risks of purchasing the stocks outright, we must emphasize the fact that buying short-term Calls has its associated risks as well. A Call buyer, especially a short-term Call buyer, is severely limited by the time-decay factor. The nearer to the expiration of an option, the less the option is worth, and the less time is remaining for the option to become profitable. Within the leverage used by gambling casinos (the house), the concept of short-term Call buying is completely understood, as well as exploited, as gamblers are considered short-term Call buyers.

Example: Consider your long-term Put, or Call, as a 6 to 8 month license to operate a casino. It allows you to capture short-term premiums; money that gamblers continuously give to you in attempting to beat the odds by speculating they will make profits on very risky bets. They feverishly feed the slot machines, ante up at poker, double-down on blackjack, or spin the roulette wheel. The odds are overwhelmingly against these short-term buyers. You, as the casino owner, continuously capture these short-term premiums, easily offsetting the expense of the license to operate the casino, then earning substantial, clear profits in the following months. They know the odds are with the casino owner, but they still take the enormous gamble on the slim chance they will hit a jackpot. The lottery works in the same manner.

On one side of the position, the transaction is definitely gambling, while on the other, the casino is simply engaging in business. Would you rather bet on the remote chance of a gambler’s rare, limited success, or rake in the steady, routine premiums captured from operating a successful business? Yes, occasionally a gambler does beat the odds to enjoy a limited, windfall return on his bet. For the casino owner, that is simply part of the cost of doing business. But we all know where the true, long-term profits lie. 30%, 40%, 50% and more, are common, and in short periods of time. The odds are with the short-term option seller, not the buyer.

When you choose a stock for short-term Call buying, you not only must carefully consider the proper stock for the type of option you are purchasing, you must also decide which direction the stock will move, then, that movement must occur within a specified, very limited period of time. Many investors have gone broke by attempting to make those same decisions. In short, time is not on the side of the short-term option buyer. It is on the side of the option seller.

Summary: 1. Buying stocks is risky.

2. Buying short-term options is less risky, but still risky.

3. Selling short-term options is the least risky, especially with a hedge, or insurance.

By selling a Call option:

1. You expect the underlying stock price to fall, so the option will not be exercised, but expire, worthless.

2. You can capture the entire premium that was paid to you, as profit. If the underlying stock price rises, you are obligated to sell 100 shares of stock at the lower strike price. If you do not already own those shares, you would then have to buy them at a higher market value, then sell them at the strike price, in order to meet your obligation. This situation is called a “Naked,” or “Uncovered” position, and is extremely dangerous. Anytime you sell a Call option you should consider buying the same option with a slightly lower strike price, and longer expiration date. This will reduce your profit potential, but will also reduce your risk considerably. (Remember the parallel twins, Risk and Reward

- If you want to reduce risk, you must also give up some degree of potential rewards. You may wish to lower your cost basis in the stock, to the extent of the premium received.

By purchasing a Put option:

1. You expect the price of the underlying stock to fall, allowing you to sell stock at the higher strike price, and thereby earning a profit.

2. This option is also used in a combination strategy as a hedge against selling Puts. We will explore that strategy later, in detail.

3. Buying Put options could also be used as a hedge, or insurance, against the possibility of a price drop in stock you already own. Consider the following:

You own 100 shares of ABC stock, and are concerned that the stock price could suddenly fall. You purchase a Put option on the same stock, with a strike price at current market value. If your stock falls in price, you would have the right to exercise your option and sell 100 shares of ABC stock at the higher strike price. The premium you paid for the option could be far less than the loss you would have incurred without that insurance. In this instance buying Puts acted as a hedge against the possibility of a price decrease in the stocks you already own. If the price of the underlying stock increases, your loss is limited to the premium you paid for the option. The option acts as an insurance policy against possible loss.

Selling a Put option without an opposing hedge -”Naked” You expect the price of the underlying stock to increase, causing the Put option you sold to expire worthless. You can then capture the entire premium paid to you, as profit. If the underlying stock price were to fall below the strike price, then you would be obligated to purchase the stock at the strike price, or pay the difference between the strike price and the stock price, if you do not want to own the stock. Your upside is limited to the premium received for selling the option. Your downside is potentially unlimited to the base value of whatever you could sell the stock for on the open market, or to the difference between the strike price and the stock price. This is a “Naked,” or “Uncovered” position, and should never be allowed to occur, unintentionally. Without the implementation of combination strategies, the main objective of the Put seller is to hope the option expires, allowing him to capture the entire option premium as profit. Nearing expiration, if the stock price moves below the strike price, changing the option’s value to ITM, and highly vulnerable to exercise, then the option seller must move quickly to buy back the option, perhaps lessening his profit potential, while also managing his risk. Even so, a small loss would be better than having to buy 100 shares of stock at inflated prices. Also, the loss can be immediately compensated for by simultaneously selling another Put expiring in the following month. We use OPM (Other People’s Money) to buffer downside risks, while buying more time for the stock price to rise.

Stock Option Trading, when done properly, can drastically reduce, or even eliminate, these two stumbling blocks to stock market success. In the first place, A trader of stock options never is not required to own the underlying stock in which an option is based. He or she can design a trade in such a way that downside risk is limited to the cost of the option, which in itself is a fraction of the cost of the stock. We capitalize on traders and speculators greed to get rich who purchase overvalued short term options bid up to inflated levels by an excess of demand over supply, by being the house or casino owner and capturing the inflated premium from the players or buyers. We buy reinsurance at a low cost by purchasing a longer term ( 5 to 6 months) out of the money option to sell the stock at a fixed price no matter how low it may drop. We buy this reinsurance ( puts ) to create a profitable hedge and sell overvalued puts repeatedly, month by month to bring the cost of our hedge down to zero and a credit so that we can enjoy a free ride capturing this inflated premium income. This strategy is known as diagonal put spreads and you do not need to pick a winner to profit.

An option is a derivative, meaning its price is based on an underlying asset. These underlying assets can either be stocks, Indexes or ETFs. An options trade involves giving someone the “right to buy or sell” a certain stock at a certain price by a specific time. Options help the investor to purchase stock at a lower price and to gain from a stock price’s rise or fall. 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 a “put” option. There is also a put and call option, whereby traders purchase both calls and puts on the same stock, with agreed prices and by an agreed date. Buying an option gives you the right, but not the obligation to purchase the asset at a specific price (called the strike price).

The hardest part of options trading is understanding all the jargon. But once you understand all the technical names, you’ll soon find out that basically what you really need to know is which way you think the stock price is going to go in the near future. Once you have an idea what’s going to happen, then all you need to do is use the right option trade to profit. For instance, if you expect a stock’s price is going to increase, then you would purchase a call option on that stock.

Options are not issued by companies like stocks are. All options that exist are “written” or sold by another trader somewhere. Therefore, you are directly betting against that person if you buy an option.

For Call options, if the price of the underlying asset is below the strike price of the option then it is “out of the money,” when the price of the asset crosses above the strike price it is called, “in the money.” This too works the opposite way for Put options. The price of the option has the greatest percentage moves when it crosses from out of the money to in the money but out of the money options also have the most risk.

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. There are very few risks and an option buyer cannot lose more than the price of the option, the premium.

There is much more involved with trading options, but these are just some of the most basic concepts to help you get started. The bottom line, is that options trading is something that you should only try once you’ve spent some time learning about the stock market, and if you can make decisions calmly when the pressure is on. A lot of information must be learnt before an educated trading decision can be arrived at.

To illustrate the concepts, let’s go on a shopping trip.

You’ve been thinking about buying a MacBook Air, Apple’s thinnest laptop, for a few days and you’ve done some research to find the best deal. You head for the mall on Saturday and spend most of the day trying to find the lowest price. This turns out to be $1799 for a 2.13 GHz MacBook Air.

Suddenly you realize that you have a dinner guest coming this evening and need to get groceries. Fortunately, the nearest store is right in the mall. Unfortunately, you discover that you forgot to bring your credit card and need to pay cash for the groceries. This leaves you with $150 plus some change.

On the way to your car you discover another electronics store, and to your amazement, the 2.13 GHz MacBook Air is advertised at $1499. Not believing your eyes, you go in and the store manager confirms the price but says that they have only one unit left. How are you going to nail down that price without sufficient cash and without a credit card?

You ask the store manager if he will hold the unit for you in return for $100, and that you will return in two hours to purchase at $1499. If you are not back in two hours, the store manager can sell it to someone else.

You make a written agreement, signed by both parties, that the unit cannot be sold to anyone else for next 2 hours but only to you at $1499 in exchange for $100, and that the $100 is forfeit if you do not return within 2 hours.

You have just engaged in “Options trading” The following options trading terminology should now make a lot more sense to you.

Options Contract – is what the note is called that you and the store manager just signed.

Underlying (underlying stock/share) – is the MacBook Air 2.13 GHz that you have agreed to pay ($1499).

Strike Price – is the agreed upon purchase price (in this example $1499).

Call Option – the type of contract in this example is a “Call Option.” It gives you the RIGHT but not the OBLIGATION to buy the MacBook Air. In order to exercise the “right to buy” you must return within 2 hours, and the store manager must sell it to you at $1499. If you change your mind, you do “not have an obligation” to buy. You simply don’t return and lose your $100 hold money.

Option Expiry – for this example the expiry is 2 hours, meaning that the option contract will cease to exist after 2 hours.

Option Premium – this is the $100 hold money you paid. It’s the cost to enter into this contract. This is not a deposit against the purchase price, but money the store will keep either way for providing you with the convenience. So, your effective purchase price will be $1599, which is still better than the $1799 “best deal” you had identified earlier, and it is the reason you entered into the contract.

Long Call and Short Call – for this example you have the “Long Call” since you are buying the contract for $100, and the store manager has the “Short Call” since he is selling the contract and gets to keep the $100.

Now let’s evaluate the risk exposure for both parties to the contract:

Your risk is limited to the $100 hold money you paid, i.e., a Long Call Option buyer’s risk exposure is limited to the premium paid. If, hypothetically, the price for the MacBook Air tumbles to $1000, then there is no way you would return and purchase it for $1499! If, hypothetically, the price shoots up to $2599 within the 2 hours, then your immediate profit would be $1000.

The store manager, on the other hand, has unlimited risk and limited profit potential. A Short Call Option seller’s risk exposure is unlimited while the profit potential is limited to the premium received. Yes, he gets to keep the $100 in case of a price drop where the buyer is not returning to purchase, but if the price for the MacBook Air shoots up to $2599 within the 2 hours, he stands to lose a lot of money because he cannot sell it to someone else for the revised price.

Hopefully, this will have taken some of the mystery out of options trading and its lingo. As illustrated by our example, we are engaged in these types of transactions in some form or other in our daily lives. We’re just not aware of it. As you gain knowledge and practice, it will come to you quite naturally.

At TradeGreeks we focus on educating investors in the world of options, where profit potential is unlimited and is not restricted to a bull market. We have created options trading strategies that are so strong and so predictable, that we can solidly stand behind an unprecedented guarantee: You will get the return we promise, or your money is refunded with no questions asked.

Visit us at http://www.tradegreeks.com for more options trading articles and register for a free membership.

This was an article from our series ‘Covert Life of Investment’.

After completing this process, you must choose between several available broker-services specialised in online trading. The cheapest solution to your problem is an execution broker. This type of online trading service provides only an electronic transaction option consisting in buying or selling shares or stocks, without any stock futures prevision, counselling or any other advisory support in finding realistic market trends.

Like all the participants in the stock exchange, you can only decide between three types of operations. The first one is buying, while the others are selling and holding. The single time when you require a broker is when you decide to buy or sell. You don’t need the assistance of an online trading broker to hold your personal stocks or already established stock futures.

The most important advantage in having an online trading account is the enhanced speed with which you can either buy or sell stocks. Of course, you’ll have a limited period of time to transact your stocks or stock futures, but once you get accustomed to the online trading market, you can start earning big money.

Obviously, this is normally easier said than done! To become an ace in the online trading of stocks and in the online trading of stock futures you must frequently analyze (usually daily) the prices’ evolution caused by the development in the leverage balance between demand and offer. This market leverage is widely generated by the market-makers or as, they’re also known, “big fish”. The market-makers are powerful companies that operate on the stock market and set the value for a specific stocks-class (for instance coffee). One of their main goals is to gain control and implicit wealth by speculating in online trading of stock futures. This way, they can raise their income by using the variation leverage of the stock market value in the online trading of stocks system.

The average stock holders and participants both in online trading of stocks and in online trading of stock futures don’t normally have any chance in front of these market giants. Of course, this is not the case for you! Now, there is help available for you on the Internet. You can choose among many free online trading services provided by PhD specialists in the evolution of the stock market.

The online trading of stocks has become an extremely appreciated occupation for many “nine to five” working class citizens who have rapidly transformed into expert stock holders. To add more points, the even more complex online trading of stock futures has generated even more “over the night” millionaires.

Nowadays, online trading has become one of the few domains in which you can start with little, and quickly earn a fortune. This is a real opportunity available for almost anyone! You only have to think of a realistic plan in buying or selling shares for the online trading of stocks or for the online trading of stock futures. It’s a great chance you should not miss.

Option trading, in and of itself, is not inherently risky. Options are simply tools. Imagine a big dial labeled, Options. You turn the dial one way and your risk goes down (as do your potential rewards). You turn the dial the other way and your risk goes up (as do your rewards, either in the form of upfront cash, or in the form of potential profits). In short, you can use options (for the right price) to reduce your risk, and you can use options (if the price is right) to generate lucrative income or receive other compensation in exchange for taking on someone else’s risk.

Let’s look at some scenarios that show each side of the risk trade.

Using Options to Reduce Risk

There are various option trading strategies you can employ to reduce the risk to your stock holdings. The price you will have to pay may come in the form of an actual cash payout to purchase that protection, or it may involve exchanging some of your future potential profits in order to acquire that protection.

Here are two trades that will reduce your risk:

Using Options to be Compensated for Assuming Someone Else’s Risk

If you are willing to assume someone else’s risk you can be compensated–and sometimes quite handsomely–for your trouble. The compensation may take the form of sharing the capital gains on someone else’s stock, or it may simply take the form of a cash payment.

Here are two types of trades in which you are compensated to assume someone else’s risk:

Conclusion:

The option trade examples above are all relatively simple but they illustrate the true nature of stock options. Trafficking in options is essentially trafficking in risk. No matter how elaborate and complex an option trade becomes, the core equation of risk is still present.

Developing and maintaining an awareness of this reality of options is crucial to your own option trading success. Whether you’re looking to reduce your risk or to be compensated for assuming someone else’s, a conscious awareness of what’s really happening in any given options transaction is invaluable. Once you know what’s really at stake, you’re in a much better position to consciously look for ways to accomplish your objectives as efficiently as possible. The outsourcer of risk will seek to reduce risk as cheaply as possible, and the assumer of risk will seek the highest compensation for the risk assumed.

However, trading stock options can be a great way to leverage your investment. For a small fee, with a defined risk, you can control a large amount of stock. The primary thing to remember, options are a wasting asset. When expiration Friday arrives, the option expires. If the option is in the money, you can either use it purchase the stock or redeem the option for the premium value. If the option expires out of the money, you have lost your investment.

Most people try to guess which direction the market is going to move, will it go up or will it go down. If they guess wrong, they lose money. More people trade with call options instead of put options, because they understand going long on the market but do not understand going short.

The vast majority of traders do not utilize trading strategies such as straddles or strangles, much less condors or butterflies. As a result, they are taking on a lot more risk, with less chance of making a profit.

If the beginning trader would take the time to learn some of the various trading strategies, they would greatly decrease their risk and improve the odds of having winning trades tremendously.

Learning the complex option trading strategies is not that hard. First you learn about the simple puts and calls options. When you understand the basic building blocks, you move on to combining the various strike prices and expiration dates. Even the most complex stock option trading strategy is made up of simple puts and calls.

These strategies will reduce the risk to a much lower level. The down side to these trades is you lower the return on the trade. But if the trade goes bad, the strategy will minimize your loss. If you still have money, you can still keep trading. If you lose all of your capital, you are out of the game.

So the people that say day trading stock options is risky are correct. But if you take these simple steps, then you can lower the risk, and still maintain the leverage that trading options will provide.