Many people are familiar with the use of company stock options by employers as a form of performance reward, financial compensation, as well as for sharing company profits with employees. However, option trading is also widely employed by large and small investors as a method for enhancing potential profits while limiting potential losses.
Option trading has attracted much attention as a quick way of making a lot of money. People interested in this type of trading should be aware that it is very risky and a lot more complicated than it first may appear. Therefore, getting a stock option education is an essential step before you get involved in option trading. This education will likely save you money in the long run.
Option trading contracts represent agreements between the buyer and the seller regarding the purchase of an underlying asset, such as a company’s stock. An option trading contract gives the purchaser the right to buy the underlying asset for a specific price within a specific period of time. Although shares of company stock are the most common underlying asset, an option contract can be applied to the sale of any asset from commodities to luxury goods.
If the purchaser has bought the right to buy the asset, the option contract is referred to as a call option. If the purchaser has bought the right to sell the asset, the contract is referred to as a put option. Call options represent the holding of a long position on an asset. Put options represent the holding of a short position on an asset.
The buyer of a call option therefore stands to profit if the asset price rises within the specified time period. If the asset price falls, the buyer of the call option effectively loses the money invested. Similarly, the buyer of a put option profits if the asset price falls during the specified time period. If the asset price rises, the buyer of the put option effectively loses the money invested.
The practice of stock option trading usually create an opening for growth to profit no matter what direction the value of the asset, or the bigger market takes. Most of the time investors will mix a portfolio of call options and put options into an inclusive strategy while will attempt to close their bets against loss of asset value.
You may have heard of stock options in the news as a form of executive compensation, but there is much more to options trading than that. A small investor should pursue a thorough stock option education initiative before investing significant money in option trading. The flexibility of stock options trading makes it possible to make money in an up or down market. It is common for an investor to use a combination of ‘put’ and ‘call’ options in a coordinated options trading plan to act as insurance in the event of an unforeseen fall in asset value.
- David Baxwell
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