How to Trade Stock Options

Knowing how to trade stock options opens up entire new worlds for the individual investor. The key advantage of options over regular stock trading is one of leverage. In order to trade stocks, it is necessary to actually purchase them at the agreed upon price. Buying 100 shares of AAPL, for example, requires a significant amount of money to be put on the table. Buying an option on 100 shares of AAPL, however, requires a much smaller amount of money that allows the investor to control the same amount of stock without actually owning it. The downside is that an option can be wiped out completely, while the buyer of the actual stock will always have something to fall back upon.

How to Trade Stock Options: All About Terminology

Some things to keep in mind regarding how to trade stock options:

• Options are bets placed on whether a particular stock will go up or down in value, and they expire after a certain period of time not to exceed nine months from the date of purchase.

• The strike price is the value at which an option will be exercised. This means that all calculations relevant to the option will be performed based on this number.

• There are two distinct types of options: puts and calls.

• A put option offers the purchaser the right but not the obligation to sell a block of stock at the strike price.

• A call option offers the purchaser the right but not the obligation to buy a block of stock at the strike price.

• Options are generally sold by investors who expect the stock to move in the direction opposite of the option they are selling.

• All stock options are American-style trades, which means that the option buyer can execute his option any time before the contractual expiration of the option.

By way of example, a call option at a price of, say, $10 would make the purchaser money if the stock were to rise above that price any time during the option period. If the stock were to shoot up to $20, the option would be exercised at $10, the option buyer would have essentially doubled his money, and the option seller would have lost a ton by making the wrong bet on which way he thought his stock was going to move.  This is how to trade stock options.

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