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Option Trading Explained - In Layman's Terms

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  • Option Trading Explained - In Layman's Terms

    Option trading often seems like a form of investment that is for the rich and professional but it is, in fact, an incredibly versatile way of investing your money. It is gaining in popularity, with traders of all experience levels taking an interest and discussing such things as credit spreads and covered calls.

    If you are a complete novice, it is helpful to start with the learning the basics. What option trading actually involves is trading option contracts on specific stocks. These contracts allow the stock to be bought or sold at a particular price (which is predetermined) within a specified time limit. There is plenty of technical information that explains exactly how this is done and you should look into it if you are considering putting money into options trading.

    There are a number of reasons why you might decide to do so. Stock options can make big profits from small investments due to leverage. Each option can control a hundred shares, so you get a greater return on your investment. This gives you control over a larger number of shares then if you had invested the same amount of money into individual stocks. Essentially you are benefiting from a discount. Your stock can be protected, as you will have the right to sell them at a specified price, whatever happens in the market. You can also use options trading to profit from both upwards and downwards movement of a particular stock. When planning your investment, you can be very creative and put together a range of different positions that can make you money whatever the market is doing.

    As with any investment, there is a downside to options trading. Leverage can work against you, amplifying your losses by the same amount that could be gained. There is an expiration date on your option, beyond which you could lose your money. You can also lose out because of the time decay effect, which can reduce the value of your options and may negate any gains from movements in the underlying stock.

    When it is effectively used, options trading can provide the investor with great versatility, by allowing them to make profits when the market moves both up and down. Thanks to leverage, it can also be a way of making big profits despite having only a relatively small amount to invest. Potential investors should always be aware that leverage is a double-edged sword. It can magnify losses as well as gains. Time decay can also eat away at profits if the options are held for too long.

    You should also think about your portfolio as a whole and make sure that your different options investments are a good fit for each other. Options offer the potential to protect yourself against downturns in the market by making investments that will profit from drops as well as rises, but only if they are chosen well. There is plenty of advice available on how to approach options trading, but it is important to rely only on the most reliable methods that demonstrate an established history of success.

    It is vital to invest carefully if you want to trade successfully in options. In addition, you must be aware of all the risks and how best to avoid them. A thorough understanding of how options trading works and with what intentions the investment is being made will allow the correct decisions to be made. Leverage options can produce the biggest profits, but they will also be subject to the largest risks. If you aren't able or willing to absorb the potential losses, you may want to stay away from this type of trading.


    Article Source: http://EzineArticles.com/3750396
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