Options Trading

A unique investment vehicle to even the beginner investing in the stock market which provides many advantages including leverage, limited risk, insurance and profits in bear markets is options trading.

Leverage

Leverage means being able to buy large quantities. First you must bear in mind that in options trading there is nothing that you will actually buy or sell. If an exchange of stocks is to occur, arrangements between two traders are made. You should also be aware that an amount known as a “premium” is paid to the seller when an option is purchased; this premium is what the option costs.

Following that, options trading leverage happens when options are bought. Options in the United States are traded with a contract multiplier of 100. This means each option corresponds to 100 shares. The contract multiplier enables even small investors to take a large exposure, or leverage, even with a small amount of capital. Successful trading this way can become very profitable.

Limited Risk

Another great feature of trading options is the limited exposure to risk that it offers. Options trading supplies an ideal method for those learning how to invest in the stock market or for those who are lacking capital. Options trading has a great advantage over traditional stock trading because you can take a view on the market direction with limited risk, while at the same time having unlimited profit potential. The reason for this is that option owners are not obliged to, but have the right to, buy the underlying stock at a price. The buyer will not exercise their right if the price does not offer any gain; they will just allow the contract to expire.

Now we’ll enhance our option trading education a bit. Let us assume we buy an option on MEW Industries with the following information:

Company: MEW Industries

Option Type: Call Option

Position: Long

Strike Price: $20

September 8th

At the time of the trade, MEW Industries was trading at $25; the Call Option was trading at $6.50. We call this the premium. It’s the price paid for the right to own the option. So if we take the premium and strike price into account at $26.50 there would be no profit and no loss; if the price were lower the investor would incur a loss; if it is more then a profit is made. The attractive thing about options trading in the stock market is that when there is a fall in the stock price, all we do is let the option, and all that is lost is the premium. Although this could be costly, it beats buying 100 shares of a $15 stock at a price of $26.50 a piece!

Unlimited Profit Potential

If should now be clear to you that these type of options strategies provide you with a win-win situation, simultaneously limiting risk whilst providing the possibility of phenomenal profits in a bull market.

This payoff benefit is not available with all option strategies. Your risk level may only become limited when you are purchasing options. The opposite is true for the option seller - their risk is unlimited whilst their profits are not. While this appears undesirable on the surface, once you have a good grasp on how options really work, you’ll find you can even limit the unlimited risk of selling strangle! (If you are not familiar with this options trading strategy, click the link)

Insurance

Another way in options trading to protect yourself and your stock portfolio is called insurance; this method can give the investor, who doesn’t want to expose him or her to risk, some insurance. One type of option is a Put Hedge, which can protect an investment even if the market becomes bearish.

The stock option trading strategy of buying puts during a bearish market to protect stock shares that are vulnerable to a decline in the market is called a put hedge strategy. Successful traders employ techniques like using a hedge to protect their investments from losses sustained during a bear market. The put hedge strategy, in addition to limiting the potential loss, has the potential to give huge profits to the investor.

Conclusion

Trading options is a great way to use the stock market to potentially make solid profits without investing a ton of capital up front. While options trading has its risks, they are often limited and yet it gives you the ability to become a really successful trader.

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