For many investors stock options seem to make more sense because the risk is lower. Lets face it with today’s economy any risk reduction is a good thing even if you do have a large pocket book. So why are stock options less risky? Rather than buying the stock itself, the buyer will only pay a percentage with the opportunity to sell the stock at a later date. But before you run off and buy stock options there are a few things you as a potential investor out to know. What options are available to you? How can stock options be purchased and how are dates important? But before we get started lets discuss some points and answer questions….
What Are the Stock Options?
When learning more about how to buy stock options you have to know that they are basically a contract between parties that is set to expire on a certain date. If you are the buyer, you’re buying the right, but not required to buy or sell this option by the time it expires. This is called Underlying. It will be bought or sold whenever the stock holder decides to exercise this right he or she has, at a price called “the strike price”.
Two main types of stock options: puts and calls. If investing in puts this gives you the right to sell the underlying in the specified period of time. Calls, on the other hand, allow you to buy the underlying. This means that you need to do some research and, if you expect that the price of the underlying stock will rise, you should invest in calls. If you anticipate the price will decrease, than puts are the best choice.
This is not always as simple as it sounds because the value of the options can change rapidly. If you own calls, you have to sell them if their price goes above the strike price, while puts owners need to buy them if the price goes below the strike price. As seller you have to be aware of the fact that you have rights and responsibilities that are opposite to those of the buyer. It is safer to sell covered calls, this meaning that you sale someone the right to buy the stocks that you actually posses. “Naked” selling implies the fact that you are selling stocks that you don’t yet own and this can be tricky.
The financial contract for call options involves the fact that the buyer of the options has the right to buy a particular asset (underlying) from the seller at a certain date and for a certain price (the strike price). However, this is not an obligation. The buyer pays a certain amount of money called premium for this right and in case he or she decides to buy, the seller has to sell at the agreed-upon strike price. Otherwise, the seller keeps the premium.
Can I Trade Options?
Before trading options you need to clearly understand what you are doing and the risks involved. You have to be aware that if the buyer makes profit, the seller loses money and vice versa. The risk is lower for the buyer because he or she can’t lose more than the premium. You have to make the difference between American and European options. The American ones can be traded at any point before they expire, while European option can only be traded at the expiration date. Trading options is either done on a public stock exchange or Over the Counter, between two parties that made an implicit agreement.
Selling Put Options
Each time someone sells an option there is a reason for doing this and the seller is expecting to somehow make some money out of this. The buyer of puts pays a premium in order to hold the right to buy that stock in a period of time and at a certain price. No matter what happens, the seller is obliged to sell at that price if the buyer asks for this. However, the seller keeps the premium if the buyer doesn’t exercise his right. In other words, an investor will choose to sell puts if a rise in price is anticipated, in order for him or her to gain the premium because the buyer won’t buy as long as the price will keep above the strike price.
How Can I Use Options to Buy Stocks?
The important thing you have to keep in mind when using options to buy stocks is that you don’t trade the actual stock, but a right. However, the options are not worth trading if the stock itself is not trustable. The advantages of stock options versus long term stock investments is that the risk is lower and the money you need for the initial investment is less.
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