How to trade stock options

Illustration of rising stock chart.

Please be advised that investing of any kind involves a great deal of risk and potential investors should do their own due diligence before they invest in anything. Nothing written in this article should be taken as financial advice and is written for educational purposes only. 

 The COVID-19 pandemic has forced many people to stay at home and stripped people from income sources as well as forcing people to stay on the internet for hours and hours on end. With the rise of virtual learning and high unemployment, people across the world and the United States have looked for unique and interesting ways to make money while staying home. Trading stocks is one of the ways people have made money during this rescission and while it is risky, skilled investors can get returns over 100 percent if they are able to time the market and make smart plays based on the companies earnings and news surrounding the company. One of the ways people make money off the stock market is called “stock options.” Stock options, by their very nature, are extremely risky types of investments and can result in losing your entire investment. New investors should look to invest in established companies and ETFs, (exchange-traded fund, which a basket of companies), rather than attempt to trade options. For the experienced investor, options can be a good way to bet on a stock going up or down. In this article, I will explain how to trade the two types of stock options, calls and puts, and explain the risks associated with both. 

Fundamentals 

A stock option is defined as, “the right to buy a specific number of shares of company stock at a pre-set price, known as the “exercise” or “strike price,” for a fixed period of time…” (1) Options are essentially a contract that gives you the right to buy or sell 100 shares of an underlying stock before a certain date. 

There are several key components of a stock option. First, the underlying stock is the underlying company that you have a right to buy 100 shares of. Secondly, a strike price is a price above or below the stock price. The closer the strike price is to the share price, the less risky the option will be, and the more expensive it will be. For calls and puts, strike prices above or below the share price mean differently. Lastly, the last component is the expiration date. If the contract is not executed or sold to someone else before the strike price, the contract expires worthless. 

Calls

Option calls is a contract that gives you the right to buy 100 shares of an underlying stock at a specific strike price. Calls are generally used to bet that the stock will go up. For example, if I believe a stock will go up in price in the future, I might buy a call option. If the current stock is worth 10 dollars, I may choose to buy a call option at 20 dollars, and as the price gets close to 20 dollars and as it surpasses 20 dollars that contract becomes worth more than it was worth when I bought it for. However, if the stock crashes, I may lose my entire initial investment. Generally, investors consider calls to be less risky than options because the price of a call option decays less. As the expiration date gets closer, and the actual of the stock is still higher than your strike price, your contract begins to decay. Meaning, that because the stock has less time to reach the strike price, the contract begins to begins to become worth less and less. 

Puts

Puts are considered to be the opposite of a call. Meaning, you have the option to sell 100 shares rather than buy. In this case, you would want the price of the stock to go down so that the contract becomes more valuable.

Anyone thinking to invest should always do their own research and make sure they are aware of all the risks associated with stocks, options, ETFs and cryptocurrency. As always, don’t invest more than you’re willing to lose. Investing can lead to high gains, but if you aren’t careful, you can lose a great deal of money. 

  1. https://www.personalcapital.com/blog/investing-markets/how-stock-options-work/

 

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