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Understanding Stock Option Trading - An Introduction

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  • Understanding Stock Option Trading - An Introduction

    Many investors make options trading seem very complex and appear as a 'no-go-area' for those who do not have experience in trading options. In fact some would even recommend that you forget about options existence as part of the financial markets completely and focus on trading traditional stocks. And this they say with good intention and reason. Why? Options trading carry with it a substantial amount of risk - risk of losing money.

    However, if truth be told, there is no aspect of the financial markets or stock trading that does not carry with it risks of financial loss. That is why it is always recommended to trade with risk capital and not your rent payment money!

    Much as there is risk involved, there are also huge financial gains to be made if you do understand what you are doing. Jumping into trading options, ignorant of the system works, will lead to frustration and failure.

    This article will introduce you the fundamentals of stock options trading, in its basic terms so that you can build upon it and trade options profitably. It takes months or perhaps even years of consistent practice to get to the point where you can safely say you know how trade options profitably. So do not expect to become a master stock options trader after reading this article. It should be just a stepping stone to many other things you need to learn.

    1. What Is An Option?

    In its simplest terms, an option is a legally binding contract that gives the buyer of the option, the right to either buy or sell the underlying the instrument, at a specified price, within a specified time frame. However, the buyer is under no obligations to carry out the buying or selling. In the stock market, the underlying instrument is either a stock or an index.

    When a buyer acquires an option, there are three choices he can exercise: he can buy the option at the agreed price, sell it at a specific price, or carry out none of the two. If he decides to do nothing, then the option expires. And the buyer loses money.

    2. Types Of Options

    There two types of options: Calls and Puts

    Call options give the buyer the right to buy the asset at an agreed price, within the time frame of the contract. If you were to buy a Call option, you hope that the stock or index price will appreciate considerably before the option reaches the date of expiry.

    Put options works in exactly opposite ways to Calls. Put options give the investor the right to sell the underlying stock within the date of expiry of the option. As an investor, you were to buy a Put option on a stock, you would hope that the price or value of the underlying stock would fall before the date of expiry of the option.

    Who Are Involved in Options Trading?

    There are four participants in an option's trading

    (1) Sellers of Puts

    (2) Sellers of Calls

    (3) Buyers of Puts

    (4) Buyers of Calls

    Buyers of Calls and Puts are under not obligation to buy or sell their options. This means that they have the choice to execute their options, or do nothing at all within the expiry date if they choose.

    On the other hand, Sellers of Calls and Puts are obliged to exercise the option they hold on the underlying stock. Thus they can either buy or sell.

    Some Terms You Need To Understand

    (1) Strike Price: This is the price an investor has to pay to purchase or sell the underlying stock.

    (2) Expiration Date: This is the date by which the call or put option on the stock must exercised or the option becomes completely worthless.


    Article Source: http://EzineArticles.com/4929983
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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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