An option is a contract that gives the owner the right to buy or sell a specific underlying security, for a certain price, for a set period of time. Each contract usually relates to 100 shares of stock; 1 contract = 100 shares, 5 contracts = 500 shares, 10 contracts = 1,000 shares, and so forth. In general, there are just two types of options; calls and puts. A call option gives the owner the right to buy the underlying equity for a specific price while the put option gives the holder the right to sell the underlying equity at a guaranteed price. Think of a call option as a coupon and a put option as an insurance policy. Most investors who think the price of equity is going up may purchase a call to make profits, while someone betting that the price of a security will drop, may buy a put. Much like using a telephone, you call up, and put down. Pretty simple.
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Myths About Trading Options, Options Are Too Complicated
This is nonsense! In many ways, learning to trade options is easier than learning to trade stocks. Think of it like this; there are only two types of options, puts and calls. Puts allow you to bet that the price on a security is going down, and calls allow you to make money when the price of your equity goes up. Pretty simple, right? And if you limit the number of securities on which you trade options, you make things even easier on yourself.
Options Are High Risk
They certainly can be! So can flying or driving a car. It’s all depends on the operator. Where it’s true that some options are highly risky, there are trades available in the options market that will appeal to the most conservative investor. The beauty of options is that you get to choose your approach based on your own unique level of risk tolerance.
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Most People Who Trade Options Lose Money
Options are a zero sum game, which means that on every trade there is a winner and a loser. There are also commissions to factor into the equation. In our experience, speculators trying to ‘make a killing’ typically end up losing money, while more sophisticated traders with a solid plan, end up with the lion’s share of the profits. Our advice; don’t take high risk trades unless you can afford the expected loss.
Options Are For Speculators
This is another very common misconception. Many options traders use options instruments to hedge other investments in their portfolio. An example would be purchasing a put against a stock you currently own to protect against a price movement to the downside. Or buying a call options against a stock you have sold short in order to cap your loss on the position. You could even sell call options against a current equity to generate income while taking no risk at all on this options trade. Options are for much more than speculating on the direction of a security.
Click Here and Register to this FREE Educational Workshop Event in Tacoma, WA on October 2, 2012.