A Simple Guide For Trading Stock Options

Trading stock options is a rather complex tool used by investors to manipulate the stock market in their favor. If you have never heard about it you might find it a little confusing, but in actual fact it isn’t. Stock options are actually what the phrase implies: a field of specialization where traders purchase ‘the option’ to buy or sell certain stocks. So in reality buying a stock option only gives you an intangible right to buy or sell a certain stock for a specific price and on a specified date.

In the real world these stocks are sold to stock option traders after the conclusion of the stock option contract. The contract brings into being a contractual relationship whereby these intangible assets assume the value of the stocks they are said to represent. So what happens is that an investor and a trader trading in such stocks conclude a binding contract. The contract normally stipulates that the trader will have the first preference to buy the investor’s stocks on the open market, at a precise price, and on a specific day.

But if the price on the specified date in question is not that which is stated in the option contract as the buying price a purchase cannot be concluded. This means the investor who sold his options benefits in the end. A simple example is where the owner of a certain stock, let’s say RT, finalizes a contract with a trader. Such contract will state that the trader gets the option to buy 50 shares of RT on the 5th of April at $10 a share. Currently the share is trading at $8.

However, unknown to the trader is that the investor knew that the RT share price was going to plunge in a few weeks. So on the day stipulated in the contract as the day a trader can exercise his/her option the share price drops like the investor predicted. Our trader in this example can therefore not buy the 50 shares for the $10. The obvious consequence is that the investor gets to keep his 50 shares, as well as the amount of money paid for the contract.

This avenue of profit is inherently risky. The reason for this is that either our trader or out investor selling the option contract can lose out. When the above example is flipped around a different scenario presents itself. What if instead of the share price plummeting it actually rises, let’s say to $12. In this scenario the previously unfortunate trader wins the option to buy these shares for the contractual figure of $10. At the end of the day he/she makes a profit of $100, with a profit of $2 for each of the 50 shares. Therefore you should always bear in mind that trade stock option careers are all about speculative activity.

Trading options is a risky business. It is for this reason that it is advised that people abstain from such a career path. Of course you might be lucky one day, but that does not happen everytime. If you want to have success trading options, you will probably want to check out a simple guide for trading stock options which can explain more of the basics that you need to know before trading options.