STOCK OPTION CONCEPTS FOR SUCCESSFUL TRADING

Stock options are a misunderstood investment tool but once understood by both traders and investors it can be a very versatile investment tool. However, as a consequence of their versatility, options are often viewed as to complex for the beginning option trader to utilize effectively. In order to avoid common mistakes of the beginning traders or investors it's important to understand a few basic concepts like types of options offered, leverage, risk control, time, and strike prices.

First, it's important to understand that there are two types of options that are commonly offered on most publicly traded companies which are called "calls" and "puts". Call options are bought when an option trader believes that the underlying stock is going to rise in share price. Now, put stock options are bought when a particular speculator believes that the price on a stock is going to decline. So from the standpoint of directional trading understand which option to trade when considering the direction of the stock you favor.

Stock options are one of the most highly leveraged financial instruments offered as the let you control blocks of stock in 100 shares per option. Where you would need $4500 to control 100 shares of a $45 stock you would only need a few hundred dollars if you had only bought options. If you are the owner of a 100 shares of stock mentioned in the previous sentence and that stock had a rally up to $54 share and you sold that holding then you lock in a 20% gain ($900 profit/$4500 original investment=%20 gain). However, if you bought an option on that stock for $300 and realized the same rally to $54 then you could realistically lock in a $900 gain then you would realize a 300% gain on the same stock!

By now, you are beginning to understand the profit potential that stock options offer you with this kind of leverage yet when you factor the ability to control risk with options you really begin to realize their potential. If you purchased 100 shares of a $50 stock or $5,000 on a given company and suddenly the company's CEO announced the company's bankruptcy you could see your investment go to zero. But, if you instead just bought call options on the stock the most you could lose is the few hundred dollars you purchased the option with. Having the ability to limit your risk is critical to your financial well-being especially if disaster strikes as in this example.

While you have enormous advantages with trading options you must gain a deep understanding of how time effects a given stock option and factor that into your trading. Options have a set time period before they expire worthless if they are not exercised and this time period can be set from 30 days to as long as 3 years depending on the stock. The expiration date occurs on the month of the option on the third Friday or available business day. The reason this is important is that any option less than 30 days is going to erode in value quickly because of time decay because the closer it gets to it's expiration day the less valuable it becomes. Depending on your option strategy its important to know the average holding days for your trading method so that you can make the best stock option selection.

Strikes or strike prices are the next critical success factor you must understand when selecting options to trade or invest. Strike prices are terms assigned to the value of the underlying instrument, stocks in this case, of a company. ABC company's stock price might be trading a $80 and it's options have strike prices at a $70 strike price, $80 strike price, and a $90 strike price which you can study in any financial periodical where option price tables are offered. Each given strike price on a company's stock has certain advantages or disadvantages just depending on whatever option trading strategy you are using. However, its enough for now that you understand what strikes are and how to implement them into your trading decision so that you can make the most effective decision when trading.

Understanding stock options and their role in your investment choices provides you with enormous potential for high returns as well as limiting your risk. There flexibility allows you to potentially profit from rising markets, falling markets, markets that are range bound, and protecting your stock portfolio from unexpected volatility in the markets. Take some time and reread this article as well as similar articles along with studying any financial newspaper that offers price option tables. The time you invest in understanding these powerful investment tools can help you take advantage of their enormous potential and improve your bottom line.

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