Tag Archive | "Trading Options"

The Basics of Trading Options

Trading Options

The Trading Options Solution

Trading options is not for the faint of heart. Unlike typical stocks, judging the usefulness of a particular option is very much an acquired skill. Options are where overconfident and undereducated traders go to lose their fortunes, but they are not all bad. In fact, those who know what they are doing in this sector can reap tremendous rewards. Doing so is simply a matter of educating yourself and being aware of the very real risks that are involved with this type of trading.

The Truth About Trading Options

It might be best to start with the truth of trading options —it is risky. It is what you are most likely to hear from any financial advisor, and there is a great deal of truth to this. Options are inherently speculative, even more so than typical stocks or commodities. The process of trading options is one that involves making a bet as to where a particular stock will stand not at the end of the day, but usually in several months’ time. Given that an option is the opportunity (but not requirement) to buy or sell at a given price at a given time, you might find that some options simply pan out better than others.

The risk associated means that any investor should be sure of his or her own abilities before attempting to deal with options. You can get advice, of course, and rely upon useful resources to help you. At the end of the day, though, you have to realize that trading in options is akin to jumping into the deep end of the pool. If you are able to swim, you might find that trading options is a great way to stay afloat financially.

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Not All Trading Options are Created Equal

Trading Options

Two Different Types of Trading Options

Trading options is not accomplished according to a single set of rules. Different categories of options require different sets of strategies. Before getting into any particular form of options trading, it is important to understand the variations between the two major types of options.

The Big Difference in Trading Options

• There are two basic ways of trading options. These are generally referred to as the European and American options.

• American, or American-style, options are written so that the buyer of the option can trigger it at any point in the life of the option. As soon as a trader feels that he has reached the point of maximum advantage, he can cash in the option. This style of option puts a premium on the instincts of the trader, who must judge the most opportune moment among many possibilities.

• European, or European-style, options are options that are played on the expiration date and no other. While most traders prefer the flexibility of the American option over the surety of the European one, the holder of a European-style option can still trade his option at a date earlier than that set for expiration, but in order to do so, he must sell the option to someone else. The option itself remains in force up to the time of expiration, no matter who holds title to it.

• Both options become worthless upon expiration.

European options are more likely to be used in the commodities markets and are never employed on stock options of any sort. They also tend to be an OTC issued device, as opposed to the American one, which is commonly found on exchange-traded securities.

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Option Tips and Strategies For Trading Options

Option Tips – Where to Learn About Trading Options

Option TipsThe 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.

Option Tips and Strategies for Trading Options

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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Trading Options For Income

Trading Options For Income –Options Trading Basics

Trading Options For IncomeTrading options for income has the potential to provide consistent profits that can serve as a primary or secondary income.  Trading options for income requires a trader to focus on the stock and commodities markets and upcoming stock and commodity moving events, since the value of options is directly related to the movement in price of the underlying stocks or commodities on which the options are based.

An Option is a financial product that is comprised of a contract to buy or sell a specific amount of the option’s underlying instrument (which is a stock or commodity) at a specified price on a future date.

An Option contract to buy a specific amount of the option’s underlying instrument at a specified price on a future date is known as a Call Option.  An Option contract to sell a specific amount of the option’s underlying instrument at a specified price on a future date is known as a Put Option.

Trading  options for income is not as simple as buying and selling stocks because making money trading options requires the underlying stock or commodity that the option is based upon to go above (call option) or below (put option) the options strike price (target price) before the option expiration date to make a profit.  If the underlying stock or commodity does not reach the strike price, then the option expires worthless.

The Advantages of Trading Options For Income

One of  the advantages of trading options for income rather than trading stocks for income is that options can be purchased for just a fraction of the cost of buying shares of a stock.  This allows options traders seeking income to commit a much smaller amount of money to play a stock’s anticipated price movement higher or lower versus actually buying or sell short a stock, which frees up their trading capital for other trading opportunities.

For example, if a trader anticipates a move higher in the price of Apple, Inc.’s stock (AAPL), the trader would pay a hefty price to buy stock in AAPL, since it trades for hundreds of dollars.  On the other hand, call options that have strike prices slightly above the current AAPL trading price can be purchased for a few dollars.  If the price of AAPL stock goes up as anticipated, then the options that were purchased for just a few dollars also go up in value and the trade becomes profitable.  This allows a trader that is trading options for income to control a lot more stock by leveraging their trade via
options.  It also allows an options trader to spread out their risk, since the extra trading capital that is available using options to trade versus stock, allows a trader to commit trading capital to a variety of different options trades.

Since trading options for income carries the risk of losing all of the trading capital committed to trading options, there are a number of options trading strategies that can employed to greatly reduce the risk to options trading capital.  See Managing Options Trading Risk for more details on options trading strategies.

Those who wish to start trading options for income are encouraged to learn as much as possible about the options market and the various ways options can be traded.

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