Trading Stock Options is a practice that allows knowledgeable investors to leverage assets. Many people are aware of the maxim, “buy low and sell high” but with stock options, it is possible to make a profit whichever direction the market is heading. Stock Options can be a great way to manage risk as well
What Are Stock Options?
Stock options can be defined as contracts that empower the buyer, known as the option holder, the right to buy or sell shares of an individual company at a specific price within an agreed time (on or prior to the expiration date). There are different types of options for buying and selling.
Calls Explained When Trading Stock Options
Trading stock options requires an expectation that the underlying stock may go up or down. If you believe that the value of a stock is going to increase, you have two options. You can buy the stock outright, or you can buy a call option which gives you the right to buy the stock at a specified price (the strike price) before the expiration date.
Puts Options Explained When Trading Stock Options
If you believe that the value of a stock is going to decrease, you have two options. You can sell the stock outright, or you can buy a put option which gives you the rauthority to sell the stock at a specified price (the strike price) before the expiration date.
How To Buy Stock Options?
You first need to decide on the stock that you want to work with. You then do your research in which you establish whether you think that stock is going to rise or fall in value. Next, you will take a look at the current option quotes. These quotes list the strike prices, premiums, and termination dates in various combinations.
All option contracts will have an element of risk. When selecting options there are four things that you must keep in mind:
1. How much risk can you tolerate?
2. What is your preferred trading time frame (day trading or long-term trading)?
3. How volatile is each potential asset?
4. What are the past returns on contracts?
When there is a high volatility of option contracts, there is both a higher risk and a higher reward. Both call and put options can be extremely profitable if you fully understand market sentiments and where the big players in the market are positioned.
What Do Stock Options Represent?
So, to recap, options are a derivative-based financial instrument related to the values of stocks. Call options permit the holder to buy the asset within the specified time frame, at a stated price. Put options permit the holder to offer the asset at a stated price within the agreed timeframe.
Stock options may be purchased on the open market, but most commonly are issued to employees of a corporation (Employee stock options, or ESOs).
Employee Stock Options – ESOs
Employee Stock options are often thought of as a perk that is associated with start-up companies. These are not typically trading stock options, they are granted by the company. These new companies may issue them to reward the early employees when and if the company were to go public. They are also a useful tool to encourage staff to remain in the company’s employ since they are canceled if the employee leaves the company
FAQ
What does “in the money” mean?
When we say a call stock option is “in the money”, we mean that the strike price is less than the stock price. With a put stock option, the reverse is true.
What does “at the money” mean?
When either a call or put options have an equal value for both the stock price and strike price, then we say that the option is “at the money.”
What does “out of the money: mean?
When we say a call stock option is “out of the money”, we mean that the strike price is more than the stock price. With a put stock option, the reverse is true.
What is a premium?
This is the payment you need to pay to buy a trading stock options contract It is also the amount you will possibly make if you sell an options contract.
What are derivatives?
Derivate describes any financial product that obtains its value from how well another one performs. The value of an option is based on the performance of stock prices, so options are “derivatives.”
What are spreads?
When an options trader purchases and sells several contracts at a variety of strike prices, this would be described as a “spread.”
Bonus Strategy
Once again, this is only one aspect of the asset quadrant. Trading stock options can be a very successful way to generate cash flow. The wealthy have seven streams of income from all four asset classes. One of the asset classes that I encourage everyone to start is their own business. For more on the asset classes, check out my other posts on Stock Market Investing. So, if you really want to find that financial freedom, you need to create a business that can become turn key to not only fund some of your real estate deals, but a business that makes money while you sleep. That is true financial freedom.
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-Cameron
