Option Trading
Options trading can be a good way to diversify your portfolio and grow your wealth, but only if you start with a full understanding of this special market. As with other types of investments, trading in stock options and commodity options without a good understanding of the risks can leave you quite a bit poorer.
Understanding the Options Market
While most often associated with stocks and commodities, options trading can take place on any asset where the price fluctuates on a regular basis Since the majority of options trades take place in the stock market our examples will focus primarily on stock options.
Consider the following scenario รณ you are watching a stock that is currently trading at $10 a share. Your research indicates that the stock should actually be worth at least $15 per share a month from now.
You could simply purchase 1,000 shares and hope for a quick profit, but few of us have an extra ten grand lying around. Another approach would be to purchase options that allow you to take advantage of any short term appreciation in the share price.
In order to purchase those stock options you would pay a premium to the seller of the options for the right to purchase those shares. The individual or institution on the other end of the trade feels that the stock will stay the same or decline over the next month, while you feel that it will appreciate. Both sides of the deal are taking a risk, and the risk taker who is right will be rewarded.
Assuming you can buy 10,000 options at 10 cents each you would invest $1,000. If as expected your stock reaches $15 per share a month later you would make $5,000. In order to pocket that money you would exercise your option to buy 10,000 shares at $10 each then sell those shares at $15 each. A cool five grand for a winning bet – that is the power of the stock option.
Of course stock option trading is not without its risks, and it is important for any would be stock option trader to be informed about these risks One of the biggest risks, of course, is that the price of the stock will go down instead of up. This is always a risk in the stock market, of course, but the importance of the stock price on a particular day is amplified when it comes to stock options.