Option trading provides a really awesome opportunity for you to make a profit in the stock market. The use of stock options in the market is quite often misunderstood and is not as difficult as many people would like you to believe it is. Some of the basics of trading should be known by you so that you can be on the road to trading successfully.
There are different levels of risk associated with trading and the level of risk comes with different types of positions. There are basically two risks - the amount in capital (money) that you are risking in a particular trade and the probability of obtaining a profit from the trade.
When choosing stock options to trade, you should make the choice provided you have leverage and limited risk. If you purchase a debit spread for $1,000 then no matter what you do or what the stock market does, you can only lose the $1,000 in capital that you invested. Options are known as a decaying asset, which means that the it has an expiry date, or time value. The time value lessens as the option moves closer to it's expiry date - and it is because of this time value that many of them expire worthless (and you've lost your $1,000). These are examples of the two types of risk associated with this type of trading - the capital that you have invested ($1,000) and the time value of your stock options expiring worthless (choosing the probability of profit within a time frame).
The time value and expiry date of an option means that you have to be accurate when you are choosing a direction for your position instead of just purchasing stock. If you purchase a call with a four month expiry date, you are limiting yourself to make a profit in only four months whereas if you owned the stock itself, you have 'limitless' time to turn a profit unless the company itself goes obsolete.
While it may seem more risky to purchase an option that simply the stock itself, you can gain quite a bit more money in less time with this type of trading. It allows you to control 100 shares for a fraction of the price, less out of pocket money for you and the chance for better profit per dollar for you. However the amount of money that you can make in profit is more limited than if you owned the stock outright. You can increase your level of profitability by researching the stock, the company and the flow of the stock in the market.
Author Bio
Sam Perdue has been actively trading the markets for over 13 years. He has written a computer program that helps traders analyze the stock, Forex, commodities and options markets using Fibonacci ratios,
Elliott Wave, option pricing and nonlinear programming algorithms. For more information, please see our
option trading software.
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