STOCK OPTION CONCEPTS FOR SUCCESSFUL TRADING

Stock derivatives, or stock options as they are commonly called, are one of the most powerful and versatile financial instruments available today yet, as a result of there profit power and flexibility, they are often misunderstood by beginning traders and investors. Yet, if a few basic critical success factors are fully understood then stock derivatives offer individuals a chance to effectively take advantage of there enormous potential. These factors include understanding kinds of stock options available, leverage, controlling risk, understanding the time relationship on stock options, and what strike prices are and how to use them.

It is vital that you understand that there are two types of options that are commonly available on exchange traded companies are called "calls" and "puts". Calls are purchased when an option investor believes that the underlying instrument, or stock price in this case, is about to rally and go higher. Put options, however, are purchased when a particular option investor believes that the share price on the company is about to fall and go lower. Once you understand the directional bias of each option alternative you understand more effectively your available choice when speculating on the direction of the stock you are analyzing.

Options offer one of highest forms of pure leverage available in the investment world and lets you control up to 100 shares of a company's stock per each stock option! If you were to invest in 100 shares of XYZ company's stock which trades at $30 per share then you would invest up to $3,000 in order to control that block of stock whereas you would only need a couple of hundred dollars to control the same stock with a single option. Lets also project that XYZ had a good earnings report and rallied to $36 a share before you sold and captured a $600 profit or 20% gain. If you instead had bought a call option it is very realistic to capture a 100% gain or greater.

Now, if you are starting to realize how powerful stock options are by offering you this kind of leverage then you will understand after reading the next few sentences that there potential for risk control is unparalleled! You see, when you purchase an option on a particular stock whatever the cost of the option is the only portion you actually risk. For example, if you buy a call option on a $60 stock that you believe is going higher and then the next day the CEO for that company announces the company's bankruptcy which results in the stock falling to zero the most you can lose in that scenario is $300. Whereas if you owned 100 shares at $60 a piece or a $6000 you could lose then entire $6000!

While you have enormous advantages with trading options you must gain a deep understanding of how time effects a given stock option and factor that into your trading. Options have a set time period before they expire worthless if they are not exercised and this time period can be set from 30 days to as long as 3 years depending on the stock. The expiration date occurs on the month of the option on the third Friday or available business day. The reason this is important is that any option less than 30 days is going to erode in value quickly because of time decay because the closer it gets to it's expiration day the less valuable it becomes. Depending on your option strategy its important to know the average holding days for your trading method so that you can make the best stock option selection.

The other success factor you must come to understand when trading options is understanding strike prices. Strikes are terms assigned on the price of an underlying stock of a publicly traded company. If, for example, ABC company's share price is at $50 its strike prices on it's available options might be a $45, $50, and $55 which you can observe in the price tables of any financial newspaper. Now, each strike price has certain pros and cons depending in large part your particular option strategy but, for now, knowing what strike prices are and understanding how to implement them in your trading decision process will you help you make the most effective selection choice.

Incorporating stock options into your investment arsenal is an excellent way to take advantage of their enormous potential for huge profits and limited risk control. So take some time and reread this article as well as study some of the price option tables in any financial site or periodical. By taking your time and devoting yourself to building a foundation on these concepts of stock option trading you can learn to take advantage of one of the most powerful and flexible trading instruments in the markets today!

Article Source: http://www.exclusive-article.com

Do you want to capture high flying stocks in the stock market just like professional stock and option traders? Read more stock option trading at www.StockOptionSystem.Com and signup for a free newsletter and receive a free ebook.
Don't reprint this article. Instead, reprint a free unique content version of this same article.

Please Rate this Article

Not yet Rated