Trading Options

So you’ve got stocks, bonds, and mutual funds in your portfolio and you probably think  it’s as diversified as conceivably possible. But there is another type of security a bit of a sophisticated financial instrument known as an option. Options are a little more advanced and can be a tad bit confusing.  They are also considered risky by many. But once you’re familiar with what they are and exactly how they work, you’ll find they are no more risky than any other speculative investment.

Options are simply contracts, or agreements. If you, for instance, buy an option, you are purchasing the privilege, but not the obligation, to buy or sell (depending on what type of option it is) the underlying asset (stock, index, EFT, etc.) at the strike price (price you lock-in).  Say your agreement allows you to purchase 100 shares of stock XYZ at any time in the next 4 months at a strike price of $25. The 100 shares of XYZ compose the “underlying asset,” the expiration date is that far off date in the future at which point the option becomes worthless/invalid, and the strike price is the $25 locked-in, or frozen price for the asset.

Now, at any time before the expiration date, you can exercise this option. For this particular scenario, that means purchasing the asset at the strike price. However, you have no obligation to do this. You can let the option expire, which might make sense if the value of the asset plummeted to something like $10 per share. But if the asset’s value skyrockets, exercising the option is a way to make some big bucks on the transaction.

There is still another alternative while trading options.  You can trade them back on the market rather than take the exercise option. By doing this, you can make money without ever actually purchasing the asset.

Which road should you take with your option? Well it’s said that around 60% of options are traded back into the market, 30% are exercised, and around 10% simply fade away to expiry without trade or exercise. Your chosen road will depend on variables peculiar to your situation, portfolio, and tolerance for risk.

Remember that options don’t have to be overly speculative. There are conservative, lower premium options with little risk and return frames that some novice option traders may find very attractive.

So figure out what works best for you and become well educated in trading options, and it could pay lucrative dividends down the road.

Related Pages

Options Trading


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