Option Trading

For many investors the stock market is a confusing and sometimes scary place. We all understand the general rule of buying low and selling high but many times timing is the most important factor in making money quickly. When is comes to investing in the stock market, slow and steady is always the best method for building value in a retirement portfolio, however it isn’t the fastest. Most people put money into a retirement plan hoping that after 20, 30 or 40 years it will have grown, allowing them to enjoy their golden years without having to worry about finances. For those seeking quicker returns to their investment an alternative to normal stock investments may be found in options trading.

Option trading may be the fastest way to make money in the stock market. Options allow small investments to offer large potential returns. Like stock equity investments, the greater potential for profit comes with greater risk as well. Option traders not only look for stocks and the overall market to rise, or gain in value, but they may also be seeking a decline in value. Investing in the stock market using options allows an investor to play the market’s ups and downs, creating a potential for making money in either environment. Where a typical stock investor gains strictly in a bull market, or one that is increasing in value, the option trader may profit in either a bull or bear market.

Well, what is an option? Unlike an equity which is part ownership in a corporation, an option is a contract to either buy or sell a stock equity. This contract or option specifies the set dollar amount that its owner may purchase or sell an equity at. It is important to understand that this is a right to purchase or sell at this set price but it is not mandatory.

An option giving the owner the right to buy an equity at a set price is called a call option. An option giving the owner the right to sell an equity at a set price is called a put option.  With this in mind, given a contract at a set price, as an equity gains value a call option will normally also gain value, however a put option will normally lose value. The exact opposite is true when an equity loses value. In this case a call option will lower in value and a put option will increase in value.

When trading in options, the face value of any contract is only fractions of that of the real stock equity which the owner gains rights to. The lower face value of these contracts allows for a much greater percentage change in price on a daily and weekly basis compared with equity trading. This great fluctuation in percentage of value is why option trading is the fastest way to make money in the stock market. Investors may even see the price of an option fluctuate by hundreds of percent in one day which is very unlikely with stock ownership.

This potential for gains is equaled with the potential to lose value. Because a contract is for the right to purchase or sell but not actually a stock itself, all options contain expiration dates. The owner must execute the option, meaning they must buy or sell the equity depending on the type of option, call or put, or they must resell the option contract to another buyer. If neither of these actions is completed before the expiration date of the contract, the option loses all value. This is the greatest difference between options and equities, because stock equities may lose value but seldom become a complete lose. Options have the potential for becoming completely worthless. Options are by far the fastest way to make money in the stock market, however they are also the most risky.

For more information of option trading check out investopedia.com