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SML - Stock Market Directory

The Amazing World of Options Trading

By: Eric Schouman

Article Category: SML Options Trading

Options are an opportunity to make buying an selling decisions later on down the road, if the market takes the right turns. By holding an option you have the right to buy or sell a specific investment at a set price within a present time period. The particular item that an option deals with is called the "underlying investment." If the stock or futures markets move in the direction that an investor thinks they will, exercising the option can make a healthy profit for the investor holding the option.

Options are traded on the stock or commodities exchange at a specific "strike price", the strike price is the dollar amount that you will pay or receive if the trade takes place. The "strike price" is set by the exchange. The market price will rise or fall depending on the performance of the underlying investment that the option is based upon.

For the serious investor, buying options is a way to capitalize on the changes that occur in market prices. Investor that buy "call" options are betting that the price of an underlying investment is going to go up. Just as investors that buy "put" options think that the price is going to go down. With either option the risk of potential loss is limited to the premium, or dollar amount that was paid to purchase the option. In the securities exchange industry this kind of trading is known as a limited, predetermined risk.

The main difference between buying options and selling them is the nature of the commitment. Buyer are under no obligation to do anything with the options that they purchase. If they choose to, they can simply let the option expire. However, seller on the other hand, have to complete a trade if the party that they sold the option to chooses to exercise the option.

The most basic form of options trading is writing covered stock calls, and it the first type of options trading that most investors do. Writing covered calls is simply selling the rights to buy stocks, that you own to another party for a specific price. The key to this is the fact the you own the stock, and that is why they are call covered.

Like futures contracts, options too can be sold for a profit before their expiration date. Although unlike futures contracts, options are frequently excercised when the underlying item reaches its strike price. This is what makes option, and stock options so appealing. They can be converted into a real investment even though the options themselves are intangible.