Options Trading for Dummies

Options are financial instruments that help traders manage risk and generate income in the market. Are you using them to their full moneymaking capacity? Perhaps you are not because you haven’t yet taken the time to familiarize yourself with how options work. This article will attempt to provide a fairly fundamental, but usable overview of options and how they can work for you.  You can think of it as kind of an options trading for dummies course.

Firstly, options are similar to bonds in one crucial way: they have an end date and their value reflects how close that particular date is to the one on your calendar. Like bonds, they mature. Options last from their start date until their expiration date and once you buy one, you have a few options. You can trade it, exercise it, or simply let it expire. How do you decide which alternative to choose?

Well with a call option, you can make money in two ways given one trend. If you buy a call option on a particular stock and the stock on which the option was purchased increases in value, you can exercise the option or trade it in the market for profit. Why is this? To understand this basic strategy, you must understand what a call option truly is.  This Options Trading for Dummies article will attempt to show you.

An option is agreement enacted between a buyer and a seller. In a call option, the buyer purchases from the seller the legal opportunity, but not the obligation, to buy a particular underlying asset (for example, 300 shares of Google – 3 contracts) at a pre-established strike price at any time prior to the expiration date also agreed upon by both parties at the time of exchange.

With a call option, the buyer is making an assumption that the underlying asset’s value will increase to a price above the strike price. In this way, the buyer makes a profit by buying the asset at the discounted strike price and selling it in the market. Alternatively, buyers can make the same profit by simply trading the option in the market. As the underlying asset grows in value, the face value of the option also grows, so it can simply be sold to another buyer in the same fashion.

So what does an option cost? An option, if left alone and not exercised, will expire worthless. The payment for the option comes at the time of purchase in the form of a fee known as a premium. For option buyers, the premium is the principal, or capital risked in hopes of making a profit. For option sellers, the premium is the only real source of income. But the premium is powerful enough to make options both risky and lucrative for all parties involved. The trick is to carry an educated level of analysis to your trading behavior and seek out profitable opportunities.

Hopefully this options trading for dummies article will help you do just that.

by: Tim Warren

Related Pages

Options Education

Options Trading for Beginners

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