Posted by Nick Niesen on November 8th, 2010
Stock options are a great way to leverage investment capital for speculation and to reduce the risk for existing stock positions in your portfolio or even to earn an extra riskless income.
There are so many option strategies that whole books were written about this topic. Before you can think about mastering advanced option techniques, you must start exploring the basic option strategies first, the simple call and put option.
What is a stock option, exactly? If you have never traded options before it might a bit overwhelming in the beginning. The theory is much harder than the praxis. Buying a call option is almost the same as buying the stock itself. Just that you need much less money, just about 10% what would be needed to buy the shares.
An option is counted in contracts and not in shares. If you buy one option contract then it equals 100 shares of stocks. Let's say you want to buy 1000 shares of Intel, then you either can buy the shares at the stock exchange or you buy ten Intel contracts at the option exchange with just 10% of the money. The leverage is the same as you would own 1000 shares.
The option gives you the right to buy 1000 shares but you don't have to buy them in real. But since you have the right to buy the 1000 shares at a fixed price, the option price is moving together with the stock price of course.
Options are easy once you understand this simple logic behind them. The other things to take care about are the expiration dates and the strike prices. All options expire one day. Until then you should have sold your option with a profit or loss, otherwise it will expire worthless. You don't really want to exercise the option to buy the shares.
You will notice that there are many options for the same stock. Each option expires on a different date with a different strike price. You must pick the option which fits your strategy best.
You will also notice that you have to pay a price for the leverage. Each day the option loses a bit of its value, no matter if the underlying stock is moving or not.
Advanced option strategies open much more possibilities. You can hedge your open positions or earn an extra income for instance. You can also make money while the stock isn't moving at all.
A final tip: most options expire worthless. That means that with the simple basic option strategies you are most likely losing money most of the time. With advanced techniques you can change sides and join the winners.
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About the AuthorNick Niesen
Joined: April 29th, 2015
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