Stock options trading offers a wealth of opportunity for the investing world. If you too want to get involved, you should first learn the basics about options, including how they work, what they do, what they are, and why they even should matter to you. Certainly traders can use options to make money several ways, but in order to do so, they must first possess an in-depth understanding of how options work.
Unlike regular shares of stock, options are actually contracts. Instead of just purchasing shares, waiting for the value to fluctuate, and then selling accordingly, stock options trading requires more strategy and incorporates more variables.
Certainly this makes the process a bit more technical. But an understanding of stocks will still be required. Ultimately, stock options are rooted in the stock market. With stock options, stock is the underlying asset. The option, however, is more about contracting the flow of these assets. If that sounds confusing, the illustrative example below will help to clear your understanding.
If a person wanted to buy an option, they would do so through a broker. So imagine they purchase an option (a call type, we’ll hypothesize.) This gives them privilege, but not the obligation, to buy the underlying asset central to the option. This kind of vocabulary is used with option trading. An underlying asset is simply, in the case of stock options, a collection of stock—for instance 500 shares of Company XYZ.
And so with this hypothetical option, said person can choose to buy these shares of Company XZY at any time before the “expiration date.” For this privilege, the buyer must also pay the seller a relatively small premium per share.
The expiration date is specified at the time the option is traded. They can buy the stock before the date or simply let the option expire, not purchasing the asset. This represents your right to “exercise” the option. If you wish not to exercise any call option you purchase, simply let it expire (or trade it on the open market, but that is beyond the scope of this article.)
But what’s the point of all that? Well, with options you can get quite a bargain on the underlying asset through what is known as a “strike price.” When two people trade an option, they specify a strike price, which is the price at which the asset is sold should the buyer choose to exercise their option. So if the strike price for the 500 shares of Company XYZ was $2/share, and the value heads north to $5/share on November 1st, exercising the option on 11/1 will bring in potential revenues of $3/share (minus the premium).
Stock options trading can be quite useful in controlling expensive assets with less money than required to purchase them.
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