How to Successfully Trade Stock Options

By: Roger Cox
Stock options are a fantastic way to generate extra income. You can profit from one of the fastest growing areas of financial investment in America. The Options Industry Council reports that the number of options contracts traded is already more two billion this year alone, a 250% increase since 2001. This means that there are more opportunities for individual investors

In case you don't know what a stock option is let me explain. Simply, a stock option gives you the right to control the ownership of a stock for a fraction of the price to buy it. There are two types of options; First, a Call Option gives you an option to buy a share of a company for a predetermined price before a predetermined date in the future. The second is a Put Option, which is the option to sell a share of a certain company for a predetermined price before a predetermined date.

For example if you purchased 100 shares in ABC Company that traded at $50 each, you would have to invest $5000 to buy those shares. However you could buy 100 Call Options priced at $5 each, with the right to buy ABC Company at $50 any time up to a date in the future (say November 16th) and you would control the same amount of shares for only $500. If the price of ABC Company goes up by $5 and you owned the shares you would have made $500 or 10% on your $5000 investment, however because the Call Options give you the right to buy the shares at $50 and they are now worth $55 the price of the options would go up $5 as well and you would have made $500 or 100% on your $500 investment.

From this example you can see the power of leverage that stock options provide.

Call Options are used when you expect the price of a stock to rise, if you expect the price of a stock to fall you can buy Put Options, which as mentioned before, give you the right to sell a stock at a predetermined price. So in the example above if the price of ABC shares fell to $45 and we had bought Put Options giving us the right to sell ABC at $50, the Put Options would be worth money because you could buy ABC shares in the market for a cheaper price than you could sell them for. This is a great benefit of options trading, you can make money in an up market or a down market!

To summarize a stock option has four components to it: 1. The underlying stock The stock that the option is traded on (ABC Company in the example above). 2. The exercise date The predetermined date, before which, you can use or exercise your option. Options always expire on the third Friday of each month (November 16th in the example above). 3. The strike price The predetermined price you can buy the stock for ($50 in the example above). 4. The type of option Either a Call or a Put option.

Here is the first key to successful stock options investing. It is very simple: practice, practice, practice. I cannot stress enough how important practice will be to your success as a stock options trader. Trading options is an inherently risky endeavor, however by learning the keys to successful stock options trading it is possible to mitigate this risk and maximize your gains. Options are a zero sum game, in a zero sum game for every winner there must be a loser. I'm sure you want to be a winner and not a loser, right? So you must take the time to learn the fundamental theories of options trading and practice the strategies behind options trading before you risk any of your hard earned capital in the market. Practice trading on paper first and once you are winning at least seven out of ten trades you can then trade in the market with your own money. By the time you have finished reading these articles you will have a plan and know just what those money management techniques are. The next article will feature Key #2.

US Government required disclaimer: Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of the Characteristics and Risks of Standardized Options. Copies of this document may be obtained from your broker, from any exchange on which options are traded or by contacting The Options Clearing Corporation, One North Wacker Dr., Suite 500 Chicago, IL 60606 (1-800-678-4667).

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