Stock Option Trading Tips

Trading stocks involves a simple transaction, with the seller receiving an agreed upon amount from the buyer, in return for the stock. Stock options, on the other hand, are slightly more complex.

A stock call option gives the buyer, or option holder, the right to purchase the stock from the seller within a specified period, at a pre-determined price. What that essentially means is that the buyer thinks the stock may rise in the future, which means that he will have purchased the stocks at the earlier, and lower, price – If the stock indeed rises. If it does not rise as expected, the buyer need not exercise his stock option. A stock put option, on the other hand, gives the stock holder the right to sell the stock at a later date.

Please note that while a stock option is not an asset by itself, but a derivative product, savvy investors who buy into the right stock options are nevertheless aware of its value, and thus able to sell and trade stock options. There is, therefore, a significant market for stock options.

The same knowledge, research, strategy and market timing is required for stock option trading, as is required for stocks. The same risks apply, albeit at a highly reduced level, in the sense that the buyer does not actually purchase the stock, and won’t lose the whole barrel if the stock tanks, instead of appreciating.

One way to play both sides of the game is to buy into a straddle. You buy into both at near the money put and call options. All that needs to happen for you to make a profit is for one of them to rise beyond the combined premium paid for both options. Such a dramatic rise is possible only under certain circumstances, like a pending regulatory announcement for a particular industry segment or a new product launch, with the company’s fate hanging on the first day sales.

Please note that this options trading strategy has its limits and risks, and a study of stock options and implied volatility is advised before you decide that this is a win-win situation. You are also advised to consult with your financial advisor and do your own research before you start trading.