The Foundation for Success in Options is Trading Education
When it comes to trading options, it literally pays to know the basics. Indeed, the first thing any option education student learns is what puts and calls are and what the obligations are as the buyer or seller of puts and calls. Here are the basics:
Buying a call option means you purchase the right to buy a certain number of shares (usually 100 shares) of a certain stock at a predetermined “strike price” prior to a predetermined date.
Selling a call option means you are obligated to sell a certain number of shares of a stock for the strike price prior to a predetermined date if the buyer exercises his or her option to buy.
Buying a put option means you purchase the right to sell a certain number of shares of a stock at the strike price prior to a predetermined date.
Selling a put option means you are obligated to buy a certain number of shares of a stock at the strike price prior to a predetermined date.
What are Premiums?
If you buy an option, your potential loss is limited to the premium you paid for the contract. The seller, however, has unlimited potential loss, but this potential loss is offset by the premium they receive from the buyer. In other words, a “premium” is an option’s price. Among other things, the premium lets option investors take a position in a market with limited capital. They can also use put and call contracts to hedge against risk in the market. For example, a put can be bought as “insurance” to protect a stock holding against unfavorable moves in the market while the investor maintains his or her ownership of the stock.
The Calendar’s Role in Options
Equity options expire on the Saturday following the third Friday of a given month. So, the third Friday is the last trading day for all expiring equity options. If the third Friday happens to fall on an exchange holiday, then the third Thursday is the last trading day. The contract no longer exists when an option expires. When that happens, an owner of an option who does not exercise it no longer has a right to exercise that option, and the seller has no further obligation to sell per the terms of the contract.
The Appeal of Leverage and Risk
The appeal of option trading is, to a large extent, related to leverage. An option buyer can pay a fairly small premium in relation to the contract value to participate in a market. In the best cases, the investor can see high gains from small changes in the underlying index. On the other hand, if the underlying stock price doesn’t rise or fall as expected while the option exists, leverage can increase losses as a percentage. Option education is the key to minimizing the risks involved with options trading.
Your Bottom Line When it Comes to Options
Once you understand what puts and calls are, you may know how to trade options, but without knowledge of the underlying asset stock, you may not trade wisely. Option education gives you a solid grounding in the elements of an options contract and how it is used. This is key to effectively using options trades to benefit your investment portfolio.
Chris Robertson is an author of Majon International, one of the world’s MOST popular internet marketing companies on the web.
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