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Options Trading Basics - Methods For Financial Fulfillment
Are you new to Options? Want to trade option? This is the initial step for you. You might know a lot of wealthy people who make lots of money using options and you'll be able to try too.
Stock and Bond trading methods run the gamut from the simple 'buy and hold forever' to the most sophisticated use of technical analysis. Options trading has a comparable spectrum.
Options are a contract conferring the right to purchase (a call option) or sell (a put option) an underlying instrument, such as a stock or bond, at a predetermined price (the strike price) on or before a preset date (the expiration date).
So-called 'American' options could be exercised any time before expiration, 'European' options are exercised on the termination date. Although the history of the terms might lie in geography, the association has become lost over time. American-style options are written for stocks and bonds. The European options are frequently written on indexes.
Options officially expire on the Saturday after the third Friday of the contract's termination month. Few brokers are available to the average trader on Saturday and the US exchanges are not open, making the effective expiration date the prior Friday.
With some simple terminology and mechanics out of the way, let's move on to some basic methods.
You will find one of two selections made when selling any option. Given that all have a set termination date, the holder may keep the option until maturity or sell before then. (We'll consider American-style only, and for simplicity focus on stocks.)
A great many investors do in fact hold right up until maturity and then exercise the option to trade the underlying asset. Suppose the buyer bought a call option at $2 on a stock having a strike price of $25. To obtain the stock the total investment is:
($2 $25) x 100 = $2700 (Ignoring commissions.)
This strategy makes sense provided the market price is anything above $27.
But suppose the investor speculates that the price has actually peaked prior to the end of the life of the option. If the price has risen above $27 but looks to be coming down without recovering, selling now is favored.
Now imagine that the market cost is below the strike price, but the option is soon to expire or the price is likely to continue downward. Under these circumstances, it may be wise to sell just before the price goes even lower as a way to curtail further loss. The investor can, at the very least, reduce the loss by making use of it to offset capital gains taxes.
The final basic alternative is to simply let the contract expire. Unlike futures, there is no obligation to buy or sell the asset, only the right to take action. Based on the premium, strike price and present market price it might represent a smaller loss to just 'eat the premium'.
Need more investment tips? For financial and business guidance, search: merger acquisitions, shell companies, and going public.
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Rodney Anderson Nationally Celebrated Consultant, Columnist, As Well As Consumer Counsel For Overall Financial Wellness
Rodney Anderson is a recognized expert, consumer advocate, author, and active member of YPO International. His broad knowledge and expertise extends to all aspects of financial well being, as well as the adversity that many consumers face
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