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Friday, June 21, 2024

Stock Option Trading

Stock option trading is seen to be very risky by some. I first learned of the risk involved when a friend of my advised me to "be careful" when trading stock options. My friend wasn’t just someone delivering a random opinion. He owned a tax and accounting firm and had seen firsthand what affects stock option trading could have on someone’s bank account.

Does this mean that stock options can’t be traded properly? Of course not. As with any other type of stock trading it pays to be prepared prior to committing real funds.

There are basically 2 types of stock options:

1) The Call Option – a call option is purchased when a trader anticipates that the stock price will rise.

2) 1) The Put Option – a call option is purchased when a trader anticipates that the stock price will fall.

Stock options have tremendous flexibility and can be used in any number of ways. Some investors use stock options as a form of "portfolio insurance". In this case the investor who is long stocks may purchase a put option that should increase in value if his stocks decease in value. With this strategy the trader anticipates that the increase in price of the put option should offset the decrease in price of his stocks leaving his portfolio equity relatively unchanged.

Some traders sell stock options to collect the premium on the option. Online stock brokers typically have more stringent requirements for traders to sell options as the risk is said to be theoretically unlimited.

Buying options is the most common type of stock option trading. Traders like buying options for a number of reasons. One of the reasons is that the cost is fixed and is lower than the cost of buying the actual stock itself. This lower cost can give the options trader excellent leverage when the stock moves in the right direction.

One of the key disadvantages of options is that there is a time limit on them. This means that after a certain time period they expire. Stock options may be purchased in a variety of expiration dates. You can buy options with a close expiration date if you feel that the stock will make a move soon. These shorter-term options are attractive to many traders because they are less expensive than options with an expiration date that is further out.

A option with an expiration date that is coming up soon may be cheaper and seem like a good deal. Remember to consider the fact that by buying such an option you have also compressed your time frame for success. In other words you have much less room for error than you would have if you had an option with more time. The general consensus is that most stock options expire worthless. Unfortunately this means that the traders who purchased these options lost money.

A mistake that many beginning stock option traders make is to always by the very cheapest option in hopes of some miraculous instant move in the underlying stock. They may actually get lucky every once in awhile but successful stock option trading is about much more than luck.