by Travis W
Have you had a hard time finding someone that can explain stock option trading in terms that you can understand?
I’ve been there, so I know your technical stock analysis. I’ve found that the ones who do understand stock options and can explain stock option trading are usually too busy making money to teach anyone.
I’ll be forever grateful to the person who took time out of their life to introduce me to stock option investing. Now I’m doing the same for you. Hopefully you’ll reap the technical stock analysis financial rewards.
In this lesson I’ll explain stock option trading and show you how profitable it can be.
Let Me Explain Stock Option Trading
A stock option is a contract, and option traders buy and sell contracts.
“Stock investors” buy and sell stock. “Stock option traders” buy and sell contracts.
Contract: an agreement made technical stock analysis two or more parties.
A stock option contract grants the buyer of that contract certain rights. It gives them the right, but not the obligation, to buy (call option) or sell (put option) a certain stock at an agreed upon price.
So the easiest way to explain stock option trading is that it’s the business of buying and selling contracts.
Stock Options Trading Example
Let’s say you discover a new business (company XYZ) and you believe it’s going to be very successful one day. You do some research and find out that it’s trading on the stock market for $20 a share. This stock also has stock technical stock analysis that you can buy.
You want to lock in the price at $20 a share just in case the stock takes off in price within the next year. So you look for a call option, because call options give you the right to buy a stock at a set price on or before a certain date.
You look up some quotes and you find an option that will give you the right to buy 100 shares of company XYZ for $20 a share anywhere between now and 1 year out. Buying the call option cost you $200.
You’re not obligated to buy the stock; you’ve just purchased the right to buy it. If you decide not to purchase the stock your contract will expire and you’ll lose your $200.
**NOTE** Buying options is always cheaper than buying stock, because you’re only purchasing a contract, not the stock itself.
This is How Buying Contracts Becomes Profitable
Time goes by and 8 months later the stock is now trading for $80 a share. Remember, you have the right, but not the obligation to purchase 100 shares of the stock for $20 a share AND you only paid $200 for the contract.
So if you wanted the stock you could exercise your contract and purchase the stock for $20 while everyone else has to pay full retail ($80).
Or you have another option. You could take the approach of an option trader. You could take that contract and sell it to someone else.
Remember, you paid $200 for the contract. You now own a contract that says you have the right to buy an $80 stock for only $20. Do you think someone might be willing to pay you more than $200 to own that contract?
Yes, any person in their right mind would.
Time to Make Some Money
You decide to sell your contract to a local stock trader for $700 and you walk away happy because you just made an easy $500 dollars or a 250% return on your money.
So now you have an example of how buying and selling a contract can be profitable. It’s also probably one of the easiest ways to explain stock option trading because as an option trader, buying and selling contracts is what you’ll be doing.
Here’s the overall lesson: As a stock option trader you’re going to invest a relatively small sum of money to buy a “contract” that controls something larger. Your research tells you that your contract will increase in value before a certain date. When it does increase in value, you’re going to sell the contract for a higher price than you paid for it and pocket the difference.
