Trading Options

If you have read: "10 Simple Rules to Make You Serious Money in the Sharemarket and Keep it!" you will have read about options.

You don't necessarily want to buy any stock, but you do want to control, by outlaying a little money. Does this sound like something you could get excited about?

Well, if so, welcome to trading options for quick returns or quick losses!

The amount you outlay is only a small part of the purchase price, but you could control a large pile of stock.

When the underlying security rises or falls your option will also rise and fall in value. Generally you can expect that options will show greater volatility and it's by trading these ups and downs that you can make superior returns, which make stock investing look foolish.

Some Important Points About Options

Option traders use volatility to make superior profits.

You can make money when the value falls by purchasing a "PUT OPTION" and you can profit from price rises when you buy a "CALL OPTION".

Now there are several option strategies, but I believe in keeping it simple - that way I understand what I'm doing and you should too!

People who buy stocks can also protect their holdings by using options - a process known as 'hedging'.

You see the idea of using leverage to buy is a very old one. Let'sface it we may not want to spend the money, but we want to control and options give us the opportunity to do so.

Options can do 2 simple things:

*they give you "the right to buy"

and

*they give you "the right to sell",

at a future time and at a future price.

You are not obligated to buy or sell, but the life of your option is diminishing from the moment you enter the contract. Soon the option will expire worthless. So you must trade it!

When we are ready, we either exercise our option, we sell the option and make trading profits - or we cancel our obligation, if we are option writers.

We can also cancel our obligation if we have written a "PUT" by buying it back. Likewise if we write a "CALL" we can buy it back and cancel our obligation to sell stock.

Okay, so if this hasn't scared you, talking about using leverage via options - let's move on.

If you buy the security XYZ at $37 and the price increases 12% to $41.50 you are using lots more of your precious money to capture the move than if you purchased say a $35(strike priced) option for $3.50 per option. Now each contract in the U.S. represents 100 shares. So your total cost is $350 per contract. In Australia one contract represents 1000 shares.

If your stock goes up it will influence the option price. Options can be extremely volatile - so you need to monitor prices very closely. So let's say your stock goes up to $41.50 and now the $35 option series is selling for $6.50. This represents an 86% price increase. So what has happened:

stock up 12%
option up 86%

Which trading opportunity do you think will make you the biggest trading profits? Would you rather hold the option or the stock? If you answered "the stock", I'd be very worried about you!

Drawbacks of Options:

Volatility - needs close monitoring.
You can lose your option money if you don't sell it before it expires.
Short life of options - usually months.
You need education in option trading.

Advantages of Options:

Leverage.
Volatility - can make more money per trade.
Less money needed than owning stocks.
Play the market UP or DOWN - flexibility.

If you increase your knowledge you could do what every other trader is doing - making money from time to time!! You see losses are part of the game - not all your trades will succeed. Playing the game with this fact in mind will help you to trade better and to have a healthy respect for the market and the necessity of controlling RISK.

Copyright (C) 2005 Joseph Sgro