Options Trading Tips - Techniques For Gaining Economic Fulfillment

Are you new to Options? Want to trade option? This will be the first step for you. You might know several wealthy individuals who make lots of income employing options and you'll be able to try too.

Stock and Bond trading techniques run the gamut from the very simple 'buy and hold forever' to the most advanced use of technical analysis. Options trading has a comparable spectrum.

Options are a contract conferring the right to buy (a call option) or sell (a put option) some underlying instrument, such as a stock or bond, at a set price (the strike price) on or just before a preset date (the expiration date).

So-called 'American' options may be exercised any time prior to expiration, 'European' options are exercised on the expiration date. Although the history of the terms may lie in geography, the association has been lost over time. American-style options are written for stocks and bonds. The European options are usually written on indexes.

Options basically expire on the Saturday after the third Friday of the contract's termination month. Few brokers are accessible to the average investor on Saturday and the US exchanges are not open, making the effective expiration day the prior Friday.

With some basic terminology and mechanics out of the way, let's proceed to a few basic techniques.

There are actually one of two choices made when selling any option. Given that all have a set expiration date, the holder can keep the option until maturity or sell before then. (We'll look at American-style only, and for convenience focus on stocks.)

A great many investors do in fact hold right up until maturity then exercise the option to trade the underlying asset. Assume the buyer bought a call option at $2 on a stock with a strike price of $25. To purchase the stock the total investment is:

($2 $25) x 100 = $2700 (Ignoring commissions.)

This technique makes sense provided the market cost is anything above $27.

But suppose the investor speculates that the price has actually peaked prior to the end of the life of the option. If the cost has risen above $27 but looks to be on the way down without recovering, selling now is favored.

Now suppose the market price is below the strike price, but the option is soon to expire or the price probably will continue downward. In these situations, it may be wise to sell just before the cost goes even lower in order to curtail further loss. The investor can, at the very least, minimize the loss by using it to offset capital gains taxes.

The final basic alternative would be to basically let the contract expire. Unlike futures, there is no obligation to purchase or sell the asset, only the right to do so. Based on the premium, strike price and current market price it may represent a smaller loss to just 'eat the premium'.

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