People trade options every day in their professional and private life. They just call it something else; they call it wise purchasing. When the price of gas is rising, consumers know which gas stations have the cheapest gas. Consumers fill up on rumors of a gasoline price increase. When the gas price is falling, consumers put off filling the tank as long as possible to get a cheaper price. Understanding options is making this same choice with stocks or the currency market. It is an awareness of the market, an expectation of a price move and the willingness to put money down in hopes of making future profit. The cost of an option is substantially less than the cost of stock.
An investor looks at the market and determines ABC stock should rise in price. This investor has $10,000 for stock purchase. The investor also thinks XYZ stock may be ready to lose money. Both stocks are currently trading at $100 a share. The investor could purchase 50 shares of each, or 100 shares of one. Understanding option trading allows the investor to take options on 100 shares of both stocks and only complete the purchase on the stock making the most money or not buy either if the stock market does not move in the directions expected. The investor would make an offer to buy an option; this investor may wish to purchase 100 shares or 50 shares of ABC stock if it goes to $105 or sell XYZ stock if it drops to $95. This person would only complete the individual transactions if the stock moved beyond the target price and the investor had a built in profit.
Understanding stock options allows people trading in this market to control larger stock groups if they are right. Understanding trading options keeps these same people from losing as much money if they are wrong. Instead of risking $10,000 in the example above, the investor may only risk $100, $200 or $500; this is how understanding options trading saves money.
The majority of these contracts expire without being executed. Stockholders taking option contracts know in advance the price they will receive if the buyer completes the contract. These people are also aware the contract may not be executed and they get the option fee plus keep the stock.
There is no mystery to understanding option trading. The purchaser buys the right to buy the stock at a set price by a future date; the purchaser is not obligated to complete the purchase. This allows an investor the opportunity to continue to study the market and adjust for any changes. The investor can buy other option contracts and execute only the most profitable ones. By understanding options an investor can take an option on more than one company without risking much of the investment portfolio and has no reason to complete any option unless the stock has made money
Understanding options allows investors to control more stock in more companies with less risk. Just like deciding when to purchase gasoline, the investor can use the knowledge of the stock market to decide when to buy stock.