Understanding Stock Options Basics

If you are considering investing in stock options I would advise you to proceed slowly before you commit any funds to this risky, leveraged investment. Options have a place in some investment portfolios it is true, but it is imperative that you first get the mechanics of stock options explained to help you determine if they are right for you or not. You also have do research on how to play the stock market.

Options are for investors to would like to use a small portion of their investment funds, say 5%, in such a way that being correct in their assessment of where the price of a stock might move pays them more than simply buying the stock would.

If you buy 100 shares of a stock at $50 a share, investing $5000, you would see a 10% return if the stock moved $55 per share. But by buying an option with a few months of life left on it that gives me the right to buy the stock at $50 per share, for let’s say $300, when the stock is at $48 per share (just as an example), we would stand to gain a lot more on a percentage basis from the same move to $55 per share.

Since each call option contract covers 100 shares of the underlying stock, the right to buy those 100 shares at $50 per share would be worth at least $500 when the stock rises to $55. The contract also has value based on how much time there is until the option expires. Even with no time at all left on the contract, the option in our example must be worth at least $500, so that we’ve achieved a gain much greater than the 10% appreciation than we would see if we had simply bought the stock and it moved from $50-$55 per share.

My purpose in this short article has been to illustrate how different buying options on a stock is from buying the underlying stock itself. Finding a great online options trading tutorial or e-course would be a great place to start.  Valuing the right to buy something is quite different from valuing the thing itself, and you can see how other factors such as the amount of time left on an option until expiration, as well as the relationship between the current price of the stock and the price at which we have the right to buy 100 shares of stock, come into play.

Once you understand options conceptually, do yourself a favor and paper trade them with the best online stock broker and trading platform you can find, for some months so that you can see just how dynamic their pricing is, and how hard it is to make money consistently trading them.  Then you can move on to trying out some stock option software when you decide you have enough paper experience, to do some live trading.  Whichever way you go, it also may be a good idea to write up your own personal investment guide when it comes to trading stock options.

E currency trading is something those with a higher risk tolerance are interested in these days.

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