Option Trading is a Science
Most of the institutions and so-called “experts” will tell you that option trading is strictly for professional share traders and that you shouldn’t even consider trading options until you have years of experience in the stock market. This is a great fallacy. I can say for myself, that I have hardly traded any shares in my time as an investor and that it is just as easy and often much less risky, to move straight into the options market rather than having to “do your time” in shares first.
Whatever course you choose to take, the one essential ingredient to success is that you follow a strict and precise trading plan. Whether you are a long term “investor” or a short term “trader” it is simply a matter of equipping yourself with the right mix of tools and you will approach the market as a “professional trader” with a high probability of success.
There are three main reasons in favour of options:
1. They provide tremendous leverage
2. Your risk is limited if things go wrong
3. Your potential profit is unlimited
What are Options and How Do They Work?
An option is a contract between a buyer and seller of an asset. They are not limited to shares, but are often used for real estate and other commodities. Either way, there are three main ingredients to an option.
1. The underlying asset
2. An agreed timeframe, after which the option expires
3. An agreed price, usually called the “strike price”.
Options contracts are being “opened” and “closed” all the time. The beauty of options is that you can choose whether to be a “writer” or “taker” of an option contract. A “writer” creates a new contract and sells it to the market. A “taker” on the other hand, buys the option contract from the market. When a writer opens a contract, they are said to be going “short”. When a taker buys a contract, they are said to be “long”.
The taker “buys to open” and “sells to close” while the writer “sells to open” and “buys to close”.
A call option gives the purchaser, the right to BUY a given number of shares at an agreed STRIKE PRICE, any time up to the agreed EXPIRY DATE. So if you believe a stock price is going to rise in the short term, you would want to buy (go long) in call options. Theoretically, after the share price has risen, you can still buy the shares at the original strike price and immediately sell them back to the market for a profit. For this reason, call options generally increase in value as the underlying stock price rises.
Put options provide different rights. They allow you the right to SELL the stock at an agreed price anytime up to the agreed expiry date. So if you expect the share price to fall, it’s like taking out insurance on the stock, because you can still sell it at the price you “insured” it for. For this reason, put options increase in value as the underlying asset price falls.
Risk Free Investing
Long term investors use put options every day to manage risk. If you bought a parcel of shares for say $40,000 you could take a put option at the strike price you paid for the shares, at an expiry date one year out. To help pay for the put option, you could also write (sell) call options at a strike price above your share purchase price. If the stock price falls, you are protected. If the price rises by the call option expiry date, you may be exercised and have to sell your shares but you will have made a capital gain. In the meantime, you receive tax effective dividends from your shares.
The beauty of both call and put options, is that you don’t have to own the underlying asset to buy or sell them. You are simply buying or selling RIGHTS to something. Because you own these rights, you are effectively controlling the asset without owning it.
Stay tuned for further updates on this most interesting subject….
In the meantime, if you would like to discover a simple system that will allow you to replace your current income source, I thoroughly recommend the Kim Reilly Option Trading DVD Home Study Course.
Get it Here
