Thinking about getting into options trading? Many traders make great income trading options on the stock market. The key is to find a strategy that works for you and stick with it. Learning how stock options work and understanding some of the most common strategies for trading options if a great place to get started.
What Are Stock Options?
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A stock option is a contract that a trader purchases that gives them the right to buy or sell shares of the stock for a specific price within a set time frame. There are two types of stock options: call options and put options. A call option gives the trader the right to purchase the stock at a set price, which is called the strike price. The put option gives them the right to sell at the strike price.
Benefits of Options Trading
Unlike simply buying an asset directly, options traders can construct different options strategies that include buying and selling single options as well as complex ones. They could even have simultaneous option positions and own both call and put options.
Understanding Long Calls
A long call is a simple options strategy where the trader buys a call option — the right to buy shares at the strike price — because they think the stock market will go up. If the market prices do go up, the value of the call option increases, and the trader can either sell the option directly, buy the shares at a lower price, or buy the shares and then immediately sell them for a profit.
Understanding Long Puts
Long puts are similar to long calls in that the trader buys the put option because they believe the market is going to move into a downtrend. If the market goes down as the trader expects it too, the value of that option increases because they can exercise their option and sell them for a profit.
Understanding the Covered Call
A covered call is a common strategy that involves purchasing 100 shares of a specific stock and also selling a call option against them. If the investor sells the call option, they can collect the premium for guaranteed additional income. This offsets the investment in the shares. The hope is that the stock price will stay below the strike price and that the owner of the call option will allow it to expire. However, it important to note that by selling the option, the trader is obligated to sell at the strike price, which limits their upside potential.
If you’re just getting involved in options trading, it can take a little time to learn the ropes. Learning the terminology and understanding the risks associated with each of the different strategies can help you better determine whether this form of trading is something you want to pursue. Ultimately, by finding a strategy you feel comfortable with, sticking with it, and understanding that you won’t always win, you will have the greatest long-term success.
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