Have you ever wanted to make money in the stock market, but you’re not sure where to begin?
Options trading is a tremendous way to earn through the stock market.
What exactly is an option?
An option is a contract giving the buyer the right, but not the obligation, to buy or sell an underlying asset (a stock or index) at a specific price on, or before a certain date.
Listed options are all for 100 shares of the asset being purchased.
The Options Workshop is the best place to learn about options in greater detail.
There are two types of Options: “Puts” and “Calls.” Some of this terminology can sound intimidating, so let me explain to you what each are.
Imagine you have a coupon from Mike’s Used Car Company that lets you buy a car for $150, and the coupon is good for 6 months. This is basically what a call option is. It gives you the opportunity to purchase the car for $150, and it expires on a certain date. It’s up to you whether you use it, or not.
Obviously, you would only use the coupon if it holds value, so if Mike’s cars are currently selling for $100, it wouldn’t make any sense to use the coupon.
However, if Mike’s Car Company is selling their cars for $200, then the coupon has $50 of real value, so you would therefore want to use the coupon.
Now, lets say that Mike’s Car Company is traded publicly on the stock market. A January 150 call option for ABC Car Company would give you the right to buy 100 shares of the company’s stock for $150 per share on, or before the call’s January expiration date.
If shares are trading for less than $150, you most likely wouldn’t exercise the call. It’s the same as using the $150 coupon on a $100 car; it doesn’t have any value. You would most likely hold onto the stock, hoping that it would go above $150 a share.
Now, lets imagine that the stock does in fact go above the $150 price to $170. You could now exercise that option and buy the shares for $150 a share. You could then re-sell them on the market for $170 each and make a profit, or you could hold on to them and see if they go even higher.
Either way, you exercised your option and bought the shares at an undervalued price. You could also sell the options contract to somebody else, so you never actually would own any shares of the company.
I used the term coupon to help explain what an option is, but I do not want you to get confused. A coupon is typically free, while an option is not. you have to buy an option, and even if you don’t exercise the option, you don’t get your money back.
Remember to calculate your risk before trading options.
Put options give you the opportunity to protect your stock if you believe that the price is going to go down in the future. Essentially, it allows you to sell the stock at a certain strike price at an allocated time, if there is a downturn.
Imagine you own 50 shares of ABC Car Company, and the stock is trading at $100 a share. Lets say you believe that the price is eventually going to drop to $80. You can buy a $90 put, so that way if the stock price does fall, you still have the option to sell the stock at the $90 price point.
This gives you the opportunity to protect your profits, or limit your losses.
Benefits of Options Trading
Cost Effective– An investor can gain a similar position using options, but have a huge cost savings. Example:
100 shares of a $100 stock would cost you $10,000.
Two $10 calls of the same stock would cost you $2,000.
Of course, this is easier said than done. You would need to make the appropriate play based on research, but the possibility is there.
Limited Risk– Options can be less risky because there is less financial commitment. Along with this, the ability to hedge is a great way to lower your risk with options trading.
All in all, it depends on how you use options. There are multiple strategies that you can use, but you can definitely limit your risk with options.
Greater Potential Returns– When options contracts are successful, they obviously pay out larger than just straight up purchasing a stock. You are getting shares of a company for an undervalued price.
If you spend less money, but make more profit it is obviously worth it.
Risks of Options Trading
Theres one obvious risk of options trading.
You can lose money.
That is why I recommend doing thorough research before making any type of decisions with options trading. Along with this, you can use practice sites with fake money to learn how to do options trading.
How can you start?
Charles, aka @Toddbillion on Twitter, has taught hundreds of people how to trade successfully using options. He provides a ton of value on the timeline as well. He is a must follow in the Twittersphere.
Understanding the risks involved with options trading is extremely important, however, if you do your research and make educated decisions, there is definitely a crazy amount of earning potential.