Trading Options: Based Upon The Cost

Do you know what options trading is? In essence, a buyer using trading options purchases the right to expect a specific action from the writer (or seller). Various types of options trading exist. Two of the most common are stock options trading and commodity options trading. This trading technique is available for use in any market where prices fluctuate. In essence, this means it can be used in all markets.

So how exactly does an option strategy work? Well suppose the price of a share is $10 today. You think the price of the share is going to increase to $12 over the next month. A great idea in this situation would be to buy lots of the shares.

Sometimes, however, you will not be able to buy these shares or you will not have sufficient funds to purchase the quantity you would like. This instance is a good example. If you have $1000.00 dollars to spend you can only purchase 100 shares. If the price rises as you anticipate, you will make a $200.00 profit. Although this is a nice return, you may have hoped for more based on your available information.

When you use trading options you pay a writer a premium and you get an option. Here is an example of how it works. You find a writer who thinks that the price of a share will not change during the next month. Perhaps he believes that it will remain stable at $10.00 per share. Then you offer him a small amount, say 10 cents per share, in exchange for the right to buy the shares at $10.00 per share later. He will probably accept that offer.

After all, he thinks they’ll still be worth $10 so he’ll be making 10 cents a share on shares he doesn’t even own, and all he has to do is sell them to you at their current price in a month’s time, if you want. At ten cents a share, your $1000 could buy you an option to buy 10,000 shares. Now if the price goes up to $12, you will have a $2000 gain because you have an option to buy them for $10,000 and can sell them for $12,000. Instead of a 20% gain, your gain is 100%.

This is how options trading can work to your advantage. However, you can lose big with options trading. Suppose the shares dropped to $9.90. This is a small drop but instead of losing $10, if you had bought the shares, you will have lost your entire bet. Despite of the risk involved one should learn option trading and use it for his benefit.

When a person engages in trading options, they are acquiring the right, but not the obligation, to buy a specific financial security at a set price for a set period of time. However, most people aren’t ina position to purchase the underlying securities most of the time, so many buy and sell options for their inherent value. An option strategy can be successful in any market that exhibits volatility. To learn option trading, one of the best ways is to trade on paper. You must understand that, prior to investing real money, you can suffer huge losses.

- David Baxwell


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March 3, 2009 | Filed Under Finance

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