SUCCESS CONCEPTS FOR TRADING STOCK OPTIONS

Stock options are a misunderstood investment tool but once understood by both traders and investors it can be a very versatile investment tool. However, as a consequence of their versatility, options are often viewed as to complex for the beginning option trader to utilize effectively. In order to avoid common mistakes of the beginning traders or investors it's important to understand a few basic concepts like types of options offered, leverage, risk control, time, and strike prices.

It is vital that you understand that there are two types of options that are commonly available on exchange traded companies are called "calls" and "puts". Calls are purchased when an option investor believes that the underlying instrument, or stock price in this case, is about to rally and go higher. Put options, however, are purchased when a particular option investor believes that the share price on the company is about to fall and go lower. Once you understand the directional bias of each option alternative you understand more effectively your available choice when speculating on the direction of the stock you are analyzing.

Options offer one of highest forms of pure leverage available in the investment world and lets you control up to 100 shares of a company's stock per each stock option! If you were to invest in 100 shares of XYZ company's stock which trades at $30 per share then you would invest up to $3,000 in order to control that block of stock whereas you would only need a couple of hundred dollars to control the same stock with a single option. Lets also project that XYZ had a good earnings report and rallied to $36 a share before you sold and captured a $600 profit or 20% gain. If you instead had bought a call option it is very realistic to capture a 100% gain or greater.

By now, you are beginning to understand the profit potential that stock options offer you with this kind of leverage yet when you factor the ability to control risk with options you really begin to realize their potential. If you purchased 100 shares of a $50 stock or $5,000 on a given company and suddenly the company's CEO announced the company's bankruptcy you could see your investment go to zero. But, if you instead just bought call options on the stock the most you could lose is the few hundred dollars you purchased the option with. Having the ability to limit your risk is critical to your financial well-being especially if disaster strikes as in this example.

With options you have an enormous advantage when trading the markets but it is very important that you understand the relationship between time and stock options. Options have a limited shelf life in that they are assigned certain time periods before they expire worthless. These time periods, also called expiration periods, can vary from 30 days to several years with expiration days typically the third Friday of the month. Understading this relationship is crucial when factoring the average holding period for a trade with whatever trading method you are using and the type of stock option you are selecting. If your average holding period for a trade is 2 months then you want to select an option two months from expiration at a bare minimum. Realistically, you want to select a option that is two months out plus another month from expiration as time decay quickly erodes the value of an option that is less than 30 days from expiration.

Strikes or strike prices are the next critical success factor you must understand when selecting options to trade or invest. Strike prices are terms assigned to the value of the underlying instrument, stocks in this case, of a company. ABC company's stock price might be trading a $80 and it's options have strike prices at a $70 strike price, $80 strike price, and a $90 strike price which you can study in any financial periodical where option price tables are offered. Each given strike price on a company's stock has certain advantages or disadvantages just depending on whatever option trading strategy you are using. However, its enough for now that you understand what strikes are and how to implement them into your trading decision so that you can make the most effective decision when trading.

By learning to implement stock options into your investment choices you can add their enormous potential for high profits and risk control to your trading arsenal. By taking some time to reread this article as well as similar material you can begin to see how they can help you profit in almost any market. Whether the market is rising, falling, is range bound, or you are just trying to protect your stock portfolio from market volatility by taking advantage of the power and risk control of stock options you can take advantage of almost every opportunity in the market.

Article Source: http://www.moneyarticlelibrary.com

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