Maybury - Options Trading: A Beginners Guide To Options Trading: Learn How To Make Money With Stock Options

Trading on the stock market can be a complicated business with as much potential for loss as gain. Options are no exception and thus are most viable in the hands of a practiced and accomplished trader. However, the investor who learns to use stock options to his or her advantage will be in a well-placed position when they incur what is known as risk capital, which are securities that are high risk but may also yield huge amounts of profit. This can be accomplished by using stock options to purchase an underlying asset.

So what exactly are stock options? The investment education website Investopedia perhaps defines it best, stating, An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. An option, just like a stock or bond, is a security. It is also a binding contract with strictly defined terms and properties (Investopedia Staff, Options Basics) . Despite its many stipulations, options trading is much simpler than the definition conveys. In short, options trading does just what the name suggests: it gives the trader options so that he or she can potentially incur minimal loss in the event that an investment does not prove fruitful .

Here is an example of options trading: Say a trader decides to purchase the stock for a new phone application that will allow users to order groceries while in transit. The trader may speculate that the value of the security is about to skyrocket due to the recent shutdown of similar applications and their companies. The buyer approaches a seller, who informs the investor that the security costs $2000. However, the investor isnt sure of his prediction and so decides to buy the asset as an option for the price of $400. From here there are two possible outcomes. First, the security may indeed increase dramatically as predicted and hoped for. That puts the trader in a powerful position, because the person who sold it to him is under the obligation to sell it to the buyer for $2000, despite the fact that the security is now valued at a much higher price; this is because the buyer already bought the $400 option. However, the trader may have speculated incorrectly, which would lead to the second and bleaker potential outcome. If the price of the security decreases, then the trader is under no obligation to purchase the security, but will lose the initial $400 premium. While that may not sound like much of a loss in this particular example, the numbers can change dramatically depending upon the asset. The potential loss may be greater either because the option to buy the asset is very expensive (greater risk and price always accompany the most attractive potential profit) or because the value of the asset has plummeted at an alarming rate. Additionally, things get more complicated when taking into account that the security may potentially rally. If the price does drop, it is up to the trader whether or not to go through with the contract, which would usually be inadvisable, with the hope that the asset will turn around and the buyer can then sell it and make a profit, or to simply allow the contract to expire and call the loss at the option premium.

As implied in the example, options are derivatives. They are called such because they derive from an underlying asset, which in this case is the phone application stock. In reality, there is an array of underlying investments from which to choose from, such as stocks, equity, government securities, or indices.