Real Estate Innovation

Option Trading Basics For Small Investors

Many people are familiar with the use of company stock options by employers as a form of performance reward, financial compensation, as well as for sharing company profits with employees. However, option trading is also widely employed by large and small investors as a method for enhancing potential profits while limiting potential losses.

Those who participate in option trading face significant risk with limited capital. This is quite different from the situation of workers who are given some stock options as a job bonuses. The possible gains and losses are elevated because stock options are a complicated means of investing which offer more leverage for success or failure. For this reason, it is crucial to get a comprehensive stock option education before you embark on the investment of major sums using this approach.

The buyer and seller enter an agreement through option trading contracts to purchase an underlying asset, including stock in a company. In the case of the option trading contract, the purchaser may buy the underlying asset for a predetermined price within a particular time frame. Typically, shares of a company’s stock are the underlying asset but an option contract can encompass the sale of any type of asset, including commodities or luxury items.

If the purchaser has bought the right to buy the asset, the option contract is referred to as a call option. If the purchaser has bought the right to sell the asset, the contract is referred to as a put option. Call options represent the holding of a long position on an asset. Put options represent the holding of a short position on an asset.

You buy a call option if you expect the asset price to rise before the option expires, so you can either exercise the option or sell it at a higher price. If you are wrong and the asset price has gone down, the option will expire worthless and the investor loses the price he paid for it. A put option works the same but in the opposite direction. You buy a put option if you expect the price to fall, and you lose if the price rises.

The practice of stock option trading usually create an opening for growth to profit no matter what direction the value of the asset, or the bigger market takes. Most of the time investors will mix a portfolio of call options and put options into an inclusive strategy while will attempt to close their bets against loss of asset value.

You may have heard of stock options in the news as a form of executive compensation, but there is much more to stock option trading than that. Unlike employees who receive a small sum of company stock options in compensation for work, small investors who are engaged in trading options are playing a risky game with limited funds. It is imperative the small investor pursue a thorough stock option education before investing significant money in such trading. The flexibility of stock options trading makes it possible to make money in an up or down market.

- David Baxwell