Basics of Stock Options
The option to trade stock options is probably not the best choice for beginners to the stock market but with a little know-how anyone can open a whole new financial dimension when you learn to trade options.
First, you need a basic understanding of what an option is and why you would want to trade the best stock options. An option is a contract that gives the person who owns it the right to buy or sell security at a particular price before a specific date. Investors can buy and sell options just like stock and use two basic types of options: the call option and a put option.
A call options is simply the right to buy a security at a certain price before a specified date. When you are looking at buying these trade stock options you should wait until the price of the underlying stock has risen. For example, if you believe that Company X’s stock prices are going to rise you can either buy the stock then or buy a call option. Let’s say that call option gives you the right to buy 200 shares of stock at the current price of $20 a share, anytime within the next 90 days. Now if you are correct and the stock prices rise to $30 a share before the option ends, you can exercise your right and buy the shares at $20 a share. This then gives you the ability to sell them immediately for a $10 a share profit. Unfortunately, like with anything the stock market cannot be predicted entirely accurately and the stock prices could drop instead. If that happens then you simply let the option expire and take the loss that was the cost of the option.
A put option is exactly the opposite of a call option. It gives you the ability to sell a security at a certain price and before a certain date. So, if you thought that Company X’s stock prices were going to fall you would want to buy a put option. You think the market will tank, so you buy a put option at $25 a share from Company X. If you’re right and their stock plummets to $20 a share, you then have the right to buy 100 shares from them and quickly sell them again at the $25 option price. This nets you a profit of $5 a share, minus the original cost of the option.
There are also a few basic facts to know when you learn to trade options. You can only trade stock options in 100 share lots but they are quoted at the per share price. So they will quote you $3 but this is the cost per share, so if you go with a 100-share lot then you would pay $300. Another term you will hear a lot when you trade stock options is the “strike price.” This is the price that you can either buy or sell the stock at as detailed in the option contract. The expiration date is the month when the option expires. This is vital to pay attention to when you learn to trade options. All options expire on the third Friday of a month. The only exception is if that Friday is a holiday, and then it expires the day before, on Thursday.
This is a very basic overview of what you should know to trade options, and gives you an idea of exactly what they are and what they allow you to do. But as with anything, this is only the beginning of understand stock options and how they work. They may not be ideal for the beginning investor but offer many tools and leverage to the advanced investor.