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How to Trade Options, The Basics

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I want to discuss, the basics of option trading. Some of you might be bored already, but please stick with me. You really should know at the least the basics of option trading. It might not be for you, but it might be exactly what you are looking for when it comes to investing.

What is Option Trading:
We should  talk about stocks for a minute. Stocks are an investment in a company and are often referred to as a “security.”

A “Security” is an financial instrument for ownership or an debt agreement . (From my College  Accounting 101 days) Basically how it works is you either “buy” or “short” stocks. “Buy” you think the stock will appreciate (go up in value) and “short” you believe it depreciate (go down).

Options are also securities. They show ownership of a right to buy or sell a stock at a given price. In a lot of ways options are very similar to stocks, but there are just a few aspects that make them a little tricky.

There are two must know parts to an option. The call or put price  (also referred as a “strike price”) and the date of expiration.

We will start with two basic examples of an options:

 

Example: Buying an option to BUY (Term is “CALL”) “XYZ company” stock for $10 a share which expires January 21, 2012.

  • This type of option is called a “call” because you can “call” on the owner to purchase the stock for $10. So if the stock is trading for $20 currently and its before January 21, 2012 – you can “call” the owner to buy their shares for only $10,  once again, you own the option to buy the stock at $10.

    Buying an option to SELL (Term is “PUT”) “XYZ company” stock for $10 a share which expires January 21, 2012.

  • This type of option is called a “put” and it works the opposite as a “call.” You may SELL your stock to someone else who has agreed to pay a price regardless of current market prices. So if the stock is trading for $2 and its before January 21, 2012 you own the option to SELL the stock for $10.Okay, that’s the basics. Now we will talk about why it can be a little confusing.