Finance Tips Trading

The Fundamentals of Option Trading

Option trading is something you can use to increase your profits when you are trading on the stock market but you will have to know what you are doing if you want to be successful.  Many traders use options to boost their profits.  Options give buyers rights to buy or sell stock at a particular price until a certain date but the buyer is not obliged to buy or sell if he or she does not want to.

The reason a trader would use options is that it gives them a lifeline in case the stock prices rise or fall.  The price a trader gets when he or she buys an option will be set until a specified date.

Advantages of Option Trading

There are a number of advantages to options trading such as lower risk, high leverage and ability to generate higher profits.  The price of an option is a small amount compared to the actual security so there is much less risk.  When a trader buys options, all he or she can lose is the amount they pay.  However, when you actually buy the security you are putting your money at more risk because if the price moves in the wrong direction, you could lose quite a bit.

Different Types of Options

Options are described by their symbol, either a put (sell) or a call (buy), the strike price and the expiration date.  Call options are bullish contracts and give traders the right to buy the securities at a particular price before the expiration date.  Put options are bearish contracts and give traders the right to sell the securities at a particular price before the expiration date.  The strike price is the set price that the trader can buy or sell the security before the expiration date.

The price paid for an option is known as the premium.  The difference in price between the strike price of the option and the actual price of the security is known as intrinsic value.

Buying or Selling Options

In most cases professional traders will sell more options than they buy and they make the most profits this way.  Options give the buyer a chance to make a larger profit with less risk but if they are not exercised before they expire, they will be worthless.  Those selling options do not have to do anything unless the person who has bought the options wants to exercise his or her right to buy.  The seller has to sell the stocks at the specified strike price if the buyer decides he or she wants to buy.  If the stock price falls below the strike price then the seller gets to keep the premium that the options buyer paid.  He can then sell another option for this stock if he wishes.  If the stock price rises above the strike price then it is very likely that the buyer will want to exercise his or her right to buy the stocks.

The biggest drawback of buying options is the fact that you could lose this money if the stock price does not rise before the expiration date.  Unless the stock price moves in the way you are expecting then you will probably lose out on the money you paid for the options.  Option trading is a bit of a gamble but if you do it properly then you can make quite a bit of money from it.