Options trading involves more risk than standard stock trading, but the payoff is considerably higher. I prefer trading options but I would recommend a beginner trader to first grasp basic stock trading before moving on to options trading. Options trading is defined as trading the option to buy or sell a stock, at a set price - called the strike price, until the option expires. With commodities, this is also known as futures trading. Options expire on the third Friday of each month. Options with expirations of over a year are called LEAPS, which stands for Long Term Equity Anticipation Securities. Option premiums (the cost to buy the option) can start as low as $.05, depending on the underlying price of the stock. The most common price range of premiums is around $2.50 – $5.00. Remember, when you buy an option, your are buying the option to buy 100 shares. So, if you buy 10 options with a premium of $2, then you will spend $2000 for your 10 option contracts ($2 x 100 shares x 10 contracts = $2000).
There are two basic options: calls and puts. A call is the option to buy a stock at the strike price. The object of a call is to have the stock price go up. Your option is considered out of the money if the stock price goes down and never rises above your strike price before expiration, then you will lose your premium – the amount you paid to buy the option. Your option is in the money if the stock is trading above your strike price.
A put is just the opposite of a call. The object of buying a put is having the underlying stock price go down. A put is the option to sell a stock at the strike price. A put is in the money if the underlying stock is trading lower than your strike price, and a put out of the money if the stock price is trading higher than your strike price.
An option can still have a premium if it is out of the money. This is considered time value. An option premium is determined by two factors: time value and intrinsic value. Intrinsic value is how much the option is in the money. Both of these factors together determine the premium you pay to buy the option (or receive when you sell the option).
Continue on to advanced options trading.
