In almost every discussion about the stock market and how to trade stocks, attention usually turns to trading options, an option being a derivative of an underlying stock, stock index, or other financial asset.
Options are a type of trading vehicle offering significant leverage for profit but with higher risks attached and where an option is a wasting asset if not exercised or sold.
As time passes, an option becomes worth less each day until reaching the final day of expiration after which it has no value and does not exist.
For those new to the field, an option is a contract between a buyer and a seller where one has the option to purchase or sell an asset for a specified period of time at a specified price.
The options are referred to as "calls" or "puts".
A call option conveys the right, but not the obligation, to buy a stock at a specific price within a specified time.
A put option conveys the right, but not the obligation, to sell a stock at a specific price within a specified time.
Leverage The main focus of attention is the leverage provided by options that can lead to many more times the amount of profit than can be obtained from a winning position in the underlying stock.
Another aspect of leverage is that a relatively modest amount of money can be invested in option contracts while allowing the option trader to participate in the action of much higher priced stocks.
Such stocks, if bought in lots of 100, could require a significant investment stake that might be too rich for a small retail trader.
Options are traded in contracts in which each contract normally controls 100 shares of the underlying stock or asset.
Trading options can involve as little as a single contract and five or ten contract trades are very common, an additional benefit to the small trader and in active markets, transactions can usually be completed within a few seconds, depending on the bid and asked situation of the moment.
Limited loss Trading options is considered to carry a much higher element of risk than buying the underlying asset but in the case of the option, with a few exceptions, the total amount that can be lost in any one transaction is limited to the total amount invested in the options.
As stated, that can be a relatively small amount easier to tolerate.
There are risk management procedures that can be implemented to control losses to some degree but there will losses.
Quote: "90 percent of option traders lose money" The opinion is often expressed that most small option traders lose money.
And so do many of the bigger traders too.
Perhaps 90 percent of option traders lose money.
If a trader can accept the inherent risks attached to options, the trading of simple calls and puts is a reasonably good form of speculation available to the smaller retail trader, the leverage is the great advantage but on the downside, time is the enemy.
Even well chosen stocks that are correctly forecast to gain in price over time may not do so within the time limit of the option that will then expire worthless.
Options can be used for speculation or for hedging.
There are dozens, perhaps hundreds of ways of trading options invoking some sophisticated and complex strategies that are best left to the experienced and knowledgeable options trader but at the basic level the use of options is a valuable tool in a speculative stock market portfolio.
Options are a type of trading vehicle offering significant leverage for profit but with higher risks attached and where an option is a wasting asset if not exercised or sold.
As time passes, an option becomes worth less each day until reaching the final day of expiration after which it has no value and does not exist.
For those new to the field, an option is a contract between a buyer and a seller where one has the option to purchase or sell an asset for a specified period of time at a specified price.
The options are referred to as "calls" or "puts".
A call option conveys the right, but not the obligation, to buy a stock at a specific price within a specified time.
A put option conveys the right, but not the obligation, to sell a stock at a specific price within a specified time.
Leverage The main focus of attention is the leverage provided by options that can lead to many more times the amount of profit than can be obtained from a winning position in the underlying stock.
Another aspect of leverage is that a relatively modest amount of money can be invested in option contracts while allowing the option trader to participate in the action of much higher priced stocks.
Such stocks, if bought in lots of 100, could require a significant investment stake that might be too rich for a small retail trader.
Options are traded in contracts in which each contract normally controls 100 shares of the underlying stock or asset.
Trading options can involve as little as a single contract and five or ten contract trades are very common, an additional benefit to the small trader and in active markets, transactions can usually be completed within a few seconds, depending on the bid and asked situation of the moment.
Limited loss Trading options is considered to carry a much higher element of risk than buying the underlying asset but in the case of the option, with a few exceptions, the total amount that can be lost in any one transaction is limited to the total amount invested in the options.
As stated, that can be a relatively small amount easier to tolerate.
There are risk management procedures that can be implemented to control losses to some degree but there will losses.
Quote: "90 percent of option traders lose money" The opinion is often expressed that most small option traders lose money.
And so do many of the bigger traders too.
Perhaps 90 percent of option traders lose money.
If a trader can accept the inherent risks attached to options, the trading of simple calls and puts is a reasonably good form of speculation available to the smaller retail trader, the leverage is the great advantage but on the downside, time is the enemy.
Even well chosen stocks that are correctly forecast to gain in price over time may not do so within the time limit of the option that will then expire worthless.
Options can be used for speculation or for hedging.
There are dozens, perhaps hundreds of ways of trading options invoking some sophisticated and complex strategies that are best left to the experienced and knowledgeable options trader but at the basic level the use of options is a valuable tool in a speculative stock market portfolio.