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How to Learn Options Trading

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  • How to Learn Options Trading

    Most people think they can learn options trading the very same way they learnt stock trading, which is just buying an options on stocks they think will do well. It's just that simple isn't it? Well, the simplicity ends when they discover that there are not one kind of option but two and each kind of option has countless strike prices and expiration dates! That's right! They suddenly realize that there is much much more to options trading than stock trading.

    Yes, stock options are a totally different ball game from stock trading even through they are used for the very same purpose of profiting from moves that stocks make. Yes, the fact that you are presented with so many different strike prices and expiration dates instantly tells you that there is no way to just pick on and profit. Much less trying to learn by trial and error. Yes, trial and error is very expensive in options trading as you cannot hold on to a mistake like in stock trading forever hoping for a come back. Options expire so options don't give you the ability to hold on to your mistakes forever.

    So, what is the correct way to learn?

    To learn how to trade options, you need to first of all learn what call options and put options are. All optionable stocks come with both call options and put options. Call options allow you to buy a stock at a fixed price no matter what price the stock is and put options allow you to sell a stock at a fixed price no matter what price the stock is. This means that if you buy a call option and the price of the stock goes up, the call option would make a profit because you still have the right to buy at a price lower than the stock price. As such, you would buy call options when you think a stock is going to go up. Conversely, put options allow you to sell a stock at a fixed price. This means that if you buy a put option and the price of the stock goes down, the put option would make a profit because you still have the right to sell at a price higher than the stock price. As such, you would buy put options when you think a stock is going to go down.

    This is only a brief outline of what call and put options are, obviously there is much more to it but this is where you start learning about options.

    After you have a clear idea what call options and put options are, you need to know what strike prices and expiration dates are. A strike price is the price agreed upon in an options contract. A call option with a strike price of $10 allows you to buy a stock at $10 no matter what price the stock is and a put option with a strike price of $10 allows you to sell a stock at $10 no matter what price the stock is. There are strike prices covering a very wide price range both higher and lower than the prevailing stock price. Which brings us to the next important thing to learn about options; Options Moneyness.

    Depending on the strike price in relation to the prevailing stock price, an option can be either In The Money, At The Money or Out Of The Money. Options of different moneyness caters to different outlooks. You would buy out of the money options when you think a stock is going to make a big move and you would buy in the money options when you expect only a relatively small move. So, unlike stock trading where you simply buy the stock when you think it will go up, options trading make you think one more step deeper into the possible degree of move in order to maximize profits.

    Complete understanding of options moneyness and the implications of options of different moneyness is impossible without an understanding of how options are priced in terms of their intrinsic value and extrinsic value. Only by understanding the difference between intrinsic value and extrinsic value and how to calculate how much of each value is in the price of an option, you cannot intelligently choose the right option for your specific outlook.

    Once you have a good understanding of what call and put options are, how they are priced and the implications of different moneyness, it is time you learn how to place options orders through your options broker. Placing options orders is another complex issue as there are 4 main order types for options trading unlike the two simple order type for stock trading. Buy to open allows you to open a new options position by buying it, sell to open allows you to open a new options position by creating a new options contract and selling it, buy to close allows you to buy back and close options you previously created and sold and sell to close allows you to sell options that you previously bought. Knowing exactly what these orders do is extremely important for knowing how to execute extremely complex options strategies.

    Yes, Options Strategies allow you to profit from multiple directions and cater to even more specific outlooks and is one of the most unique features of options trading. Putting different options both long and short together produces strategies that go beyond simply profiting when a stock goes up or down. There are literally hundreds, if not thousands, of options strategies and some are so complex that a single position consists of 4 to 8 different trades utilizing a complex combination of the different order types you learnt above. In fact, each option strategy is a study on its own that requires long period of learning and trading to master.

    After you have learnt all of the above can you start placing some simple options trades and know exactly what you are doing. See how much learning it takes to place your first options trade? Yes, options trading require investment knowledge that goes beyond merely buying and selling and is as much a science as it is an art. Follow the above steps, do your due diligence and you will be all set for your first options trade.


    Article Source: http://EzineArticles.com/3713100
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    "Step into the arena and hold on to your hat. Don't get discouraged if you don't make 8 trillion dollars in your first month. Trading is not a get rich quick scheme. Realize that trading is a skill and just like any other skill it takes time to learn. Have convictions in your decisions in life and trading. Ignore the comments and "advice" of those that have never traded a day in their life."

    Good KARMA and positive energy abound.


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