Options are contracts representing the right to buy or sell shares of a stock by a predetermined date. The two types of options are puts (contracts for the right to sell shares) and calls (contracts for the right to buy shares). If you are buying an option, you have a "long position," and if you're selling an option, you have a "short position." Options contracts typically spell out the following:
Whether it's a put or a call option
The quantity and name of the underlying shares (usually 100 shares)
Strike price - the price at which the underlying transaction will occur
Expiration date, or the last date an option can be exercised
Settlement terms, like whether the seller must deliver the actual asset or an equivalent cash amount
The "premium" paid by the purchaser of the option
What Are Options Good For?
Options can amplify losses, but they can also amplify gains. When used by educated investors, they can improve a person's investment portfolio. But poorly informed use of options can do just the opposite. Options offer flexibility in many investment situations and can be designed to enhance your situation in many ways. For instance, they can:
Protect stock holdings from a drop in market prices
Increase income against your current stock holdings
Help you buy stock at a lower price
Help you determine your position for a major market move, even if you're unsure which way prices will go
Benefit from the rise or fall of a stock's price without the costs of buying the stock outright
Why Trading Education and Option Education are Essential
Charles R. Morris, former banker and contributor to The Los Angeles Times and The Wall Street Journal said, "In raw markets, the scent of money deadens all other sensory and ethical organs." To use options to your advantage, you must ignore emotions and have a clear understanding of the intrinsic value of the stocks involved. Since options derive their value from an underlying stock, it is critical that you understand that underlying stock before using options.
An Educated Trader is a Better Trader
Derivatives like options aren't for sissies. While derivatives aren't inherently bad, they can result in amplified losses for those who trade without knowing what they're doing. Option holders do not have the rights that stockholders have, like voting rights or special dividends unless they exercise a call option and take ownership of the underlying shares. Traders in options exchange markets participate in a complex, auction-like market where option terms are set, and where strike prices are determined by a variety of factors. Learning about options trading is critical for success.
What to Look for in Trading Education
Before considering options trading, you'll need to learn what options are, terminology associated with options trading, as well as some basics such as how an option chain works, futures versus equity options, buying calls, buying puts and what covered calls are.
Once you understand how options work and are prepared to research the underlying assets of options you're considering trading, you can make educated decisions that will help you use options to improve your investment portfolio.
Author Resource:
Chris Robertson is an author of Majon International, one of the world's MOST popular internet marketing companies on the web.
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