Trade Options

Trading in stock options is not a cup of tea for beginners in this market, but if you study well and complete your homework, then probably you will be able to invest in these options as well. Options are actually contracts that provide the owner with the right either to buy or to sell an underlying stock at a predetermined price before or on the expiration date. It is a right and not an obligation.

Options available in Stock Options

Trading in stock options gives you three choices to select from:

• You may exercise your option to buy or sell the stock held
• You may trade the options
• You may use these options as hedge to protect yourself against potential loss

The following article will give you basic guidelines to help you to understand trading of stock options.

Exercising the Option:

If you have bought an option either to buy or sell a particular stock, then you can exercise this option at any time on or before the contract expires. This option gives you the freedom to buy or sell your stock at a fixed price irrespective of the current price of the stock in the stock market.

Let us consider a case where you believe that the price of a particular stock is going to rise in near future and so you buy a ‘Call’ option which is quite close to the current stock price. So, in future, if the price of that stock rises significantly before your contract expires, then you can exercise your option to buy that stock at that lower price that was fixed at the commencement of the contract. You can also hold onto the stock to increase or book your profit. Your profit in this case will be the difference between the current stock price and contract price minus the cost of buying the option and other commissions, taxes etc.

This same technique would hold true for a ‘Put’ option (the right to sell) at a predetermined price when you are of the opinion that the price of a stock is going to fall in future.

Trade Options:

The profit or loss of an investor depends on two main factors. These are:

• The current price of the stock on the stock market. As this price moves, the profit or the loss will also move.
• The time that is remaining between the current date and the contract’s expiration date also affects the profits. The greater the time gap, the greater will the profits and vice-versa.

Although the demand and supply for the option also influence profits, it is these above mentioned two factors that primarily affect the size of profits.

Using Options as Hedging Instruments:

Traders often use options as an insurance against potential loss if they feel that the price of a stock is going to fall. Sometimes, they also use options to reduce their losses. Actually, the best method to keep the losses minimum is to always have a stop-loss while executing your order, but if you have not used this option while executing the trade, then you can use the options to prevent from further losses.