Investments: Options (Stocks)



What Is It? 

Options are privileges sold by one party to another which offers the buyer the right to buy (call) or sell (put) a security at an agreed upon price during a specific period of time or on a precise date.

Two Basic Types of Options (Calls and Puts)

A call option gives the owner the right to purchase an asset (mostly stocks) at a specific amount within a precise period of time.

Buyers of calls anticipate that the stock will upsurge greatly before the option expires, so then, they can buy and resell the amount of stock specified in the contract quickly or just be paid the difference in the stock price when they go to exercise  the choices.

A puts option gives the owner the right to sell an asset (mostly stocks) at an exact price within a specific period of time. Puts option are the same to having a short position on a stock.

Buyers of puts option are making a bet that the price of the stock will drop before the option expires. Therefore, allowing them to sell it at a price higher than its current market price and gain an instant profit.

The strike price or exercise of the options is what the stock price must pass (for calls) or go below (for puts) before options can be implemented for a profit.

All of this should happen before the maturity date, also called the expiration date. The options give the owner the rights, not the obligation, to do something and this should be noted. The holder is not required to use if he/she does not want to or if the terms are not favorable. 

Objectives and Risks 

For most options strategies, you must have very high risk tolerance. It is not uncommon for a stock option to change 30-40% or more in one trading day. 

The objectives of options are up to the owner. There are two types of people who use options: Speculators and Hedgers.

The Speculators simply purchase an option because they believe the stock will go either up or down over the next little while.

Hedgers use options strategies, like the covered call, which allows them to lessen their risk and essentially lock-in the current market price of a security. Options are popular with institutional investors because they permit institutions to control the amount of risk they are exposed to. 

How To Buy or Sell It 

Options trade very similar to stocks and can be purchased through just about any discount or full-service broker. 

To trade options, you need to be permitted by the brokerage first. They will normally ask questions to decide if you have enough knowledge or experience before they will approve you. Options are usually purchased through a margin account or borrowed money.

Two Main Uses

Capital Appreciation

Increase Leverage

Strengths

Allows you to severely upsurge your leverage in a stock if you are speculating.

Options on 100 shares will cost less than actually purchasing the 100 shares.

If used correctly, options can be a very useful tool in hedging contrary to an existing position.

Weaknesses

Options are highly complicated and highly leveraged. If you are using options to speculate, you need to watch over them very closely and to have a high risk tolerance.

Options need more than just a basic knowledge of the stock market.  

If you take numerous position, there is a chance to lose lots of money. For instance, if you are the writer of an option.

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