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Understanding Options Trading

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  • Understanding Options Trading

    Building Wealth Through Options Trading

    If you want to build your wealth for your future and your family's future, chances are you have been told by financial advisers to invest in mutual funds or government bonds, or perhaps in the stock market. They all sound good, and are great ways to build wealth. However, when it comes to a downturn, these investment vehicles are totally affected, and the value of your investments would decrease.

    Have you ever thought of trading the market when it's going down and making money when the market is going down? For many, this sounds like an impossible situation, but it's not! This is where options trading come into the picture. With options trading, you can make money whether the market is going up or going down. There are ways to make money with options trading when the market is going up, and another way to make money when the market is going down.

    Understanding Options Trading

    Let's defined some terms here first. Options trading are still associated to the stock market. In essence, you are still looking at the prices of stocks, as these are the basis for options. Now, Options are defined as instruments that give the holder (or buyer) the right but not the obligation to buy or sell shares on or before an agreed date for an agreed price. This means that options are like a piece of paper that entitles you to buy or sell stocks or shares if the stock price reaches or goes above the agreed price on or before the expiry date (which is the agreed date). This, in essence, gives you control of stocks, whether you own the stocks or not. If you have to sell or buy the stock as per the terms of the options contract, that term or act is called being "exercised".

    There are 2 kinds of options: a Call Option and a Put Option. A Call Option gives the holder or buyer the right but not the obligation to BUY the stock on or before an agreed date for an agreed price. A Put Option, on the other hand, gives the holder or buyer the right but not the obligation to SELL the stock on or before an agreed date for an agreed price. For each of the two types of options, you can either Buy it or Sell it, meaning you can buy a call option, or you can sell a Call option. This is the same for the Put Option.

    The buyer of an option has to pay a premium for the right to potentially exercise the option, whereas the seller of the option receives a premium for giving that right to the other party.

    In understanding options trading further, we need to know how they can be beneficial and how they can be used. Options can be used in different ways:

    1.) Income generation - If you own a stock, you can sell a call option for a strike price higher than the current market price, and you can receive a premium from it. If you get exercised on the expiry date of the option, you would have to sell your stock at the agreed price (strike price), BUT, you get to keep the premiums for the call option. If you don't get exercised, then you get to keep the stock, PLUS, you get to keep the premium from selling the call option.

    2.) Protection from the downside - If you own a stock, and you want to risk only up to a certain level, you can buy a Put Option to sell the stock at that lower price level. That way, if the market suddenly collapses (like in the recent times), you only lose up to the strike price of the Put Option you purchased and nothing more (even if the market price is even lower than the strike price).

    3.) Make Money on the Downside - You can combine buying and selling a call option OR Buying and selling a put option and make money from the difference between the premium received and premium paid. This technique is called credit spreads, and is one way you can make money when the market goes down. If you pick the right levels for the call options, you can make money from the difference or the credit of call options without getting exercised.

    These are some of the basics of Options Trading. Understanding Options Trading is not something that happens overnight, yet it is quite simple once you grasp the idea. It is a great way to leverage your stock portfolio and make some extra income. The rewards of trading these strategies can vary, but I can guarantee you that they're better than leaving your money in a savings account. However, do note that you need prior knowledge and understanding in order to succeed in making money from options trading.



    Article Source: http://EzineArticles.com/2555119
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    Good KARMA and positive energy abound.


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