Posted on 18 March 2012.
The most important of all option tips is that before even considering trading options, take the time to learn about options trading and options trading strategies. A preliminary options trading education and introduction to option tips can be found in the following articles: Option Trading Basics, Trading Call Options, and Managing Options Trading Risk.
Investopedia.com provides a good introduction to options trading and option tips in an entry called Options Basics: Introduction. More detailed options trading information and option tips are available at Optiontradingpedia.com. These are just two of many sites on the Internet that provide options trading information and option tips. It is highly recommended that an investor that is new to options trading gain a firm understanding of the risks and rewards associated with options trading prior to commencing with options trading.
One of the most important option tips is to understand that options have a number of different uses in the stock and commodities markets, and therefore, options trading strategies vary depending upon why options are purchased. Certain options trading strategies do not apply to every options trade.
Call options are purchased when one anticipates that a stock or commodity will make a move higher before the option expires. Put options are purchased when one anticipates that a stock or commodity will make a move lower before the option expires. Buying put and call options can be used as a pure trading strategy to try to make money from an anticipated price move or as a hedging trading strategy to protect an existing position held in a stock or commodity.
The most common of all option tips is to buy Call options for a stock or commodity you expect to move higher rather than the stock or commodity itself. Call options allow traders to reduce the amount of capital needed for a trade and to protect against an unanticipated drop in price of a stock or commodity. The advantage of playing a stock or commodity on the long side via Call options is that the downside risk can be quantified as the price paid for the option. Also, not as much money has to be committed to the trade since Call options cost just a fraction of the price of a given stock or commodity.
Another one of the common option tips is to buy Put options to protect the downside risk of a stock or commodity one is holding long, but does not want to sell. A Put option gives one the right to sell the amount of shares or commodity covered by the option (typically a block of 100 shares for each option) at the specified option strike price prior to the option expiration date. If one has a gain in a stock or commodity and want to ensure that no matter what happens to the price of the stock or commodity due to unforeseen events, one can get out with a profit, Put options are a good way to protect that gain.
One of the commonly overlooked option tips is to use limit orders to buy and sell options. Use of limit orders when buying and selling Call and Put options can save money, especially if one is an active options trader.
A summary of option tips would not be complete without the standard warning that all options traders must understand about the difference between stocks and options. Unlike stocks, options suffer from price decay as they approach their expiration date, which means they methodically lose value over time. Once the expiration date is reach, an option will expire worthless, unless the strike price of the option has been exceeded to either the upside or downside, depending upon if it is a Call or Put option.
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