Exercising the Option to Buy or Sell

What Options Can Do

Options trading on the stock market is an additional way to diversify your investment portfolio. This differs from trading options and futures on commodities.

Stock market options trading involves contracts which give an owner the opportunity to buy or sell a security at a fixed price either before, or on, the date the contract becomes due. Investors can either trade the security itself, or trade the option. Some investors choose to use options trading as a hedge against losses in other segments of their portfolios.

Let’s take a look at exercising the option to buy or sell a particular stock for which you have a contract. You have any time up until the contract’s expiration date to decide what you want to do. You can either take the stock or sell them at the price fixed on the contract no matter what their current value on the market might be.

Consider this example in options trading. There is a stock you have had your eye on and because of your research and analysis of historical trending reports, you believe the price of these stocks will rise. Should you be concerned that the price may not rise as you expected, you would probably wish to buy a call option that is close to the price on the current market.

Before that option expires, the stock price may increase quite a bit. In that instance, you would exercise the option to buy at the lower contract price.

Conversely a put option gives you the right to sell at a fixed price. You would buy a put option if your research indicated the stock price would likely fall.

Now your options trading choice is whether to keep the stock and its built-in gains, or sell it and take your profit. Of course, there will be fees due out of this profit which pay for the cost of the option itself, taxes, and brokerage commission.

Options trading is not as straightforward as you might believe. The beginning investor would do best to use a good deal of caution and the benefit of a mentor’s experience before attempting to profit from options trading. Mentors can help save you all the pain of making unnecessary losses, so I suggest you find one, and grab a book to learn from.

Options Trading: Hedging Against a Loss

One way that many investors use options trading is as a hedge against possible losses in stock price that might result from market fluctuations.

When you trade in options, you have three choices as to how to make a profit. You can buy or sell the stocks (pick an option that is most likely going to be exercised), trade the option itself, or use the option as a hedge. In this article, we will briefly examine how to use options trading as a hedge against loss.

Options trading can be considered much the same as an insurance policy. If you feel that a stock price is going to drop but are hesitant to sell in the current market, then you may opt to buy a put option when the price falls just below the current market value.

In options trading, a put option is one that gives the owner the opportunity to sell their stock shares at the agreed strike price. In this way, if the stock’s value decreases, the investor can exercise this option and sell his or her shares at a profit – the higher price. Another choice is to sell the put at a profit, which reduces the cost of acquiring the stock in the market.

Of course, if the price of the stock does not decrease, then the investor loses what he paid for the price of the put. There is still an option to sell the put option before the contract’s expiration date and recoup most of this cost, if desired. Or you could also put in a stop-loss order to your broker in order to prevent a loss. This is just another method of loss insurance.

While using options trading as a way to hedge against losses can be a great strategy for the experienced trader, it may not be the best choice for a novice investor. Take some time to get used to reading market conditions and improving your accuracy regarding rising and falling prices before relying on options trading as a portfolio insurance policy.

Learning to trade options is not difficult. I certainly had no prior knowledge of trading the markets until I stumble on Planet Wealth's ebooks, which have been a great resource for my learning. Make no mistake, options can be tricky to trade, but when armed with the knowledge, it can be one of the most powerful instruments you can use to make money in the markets without having to monitor it 24 by 7.

Another Sharemarket secret unveiled!

Credit Spreads - unveiling the myth

What is a Credit Spread?

Credit Spreads are a great way to make money in the market without having to own any shares. I'm assuming for this post that the reader already has some understanding of what options are. If you want to get an idea of what they are, I have briefly discuss them on my first post. This strategy is offered by Planet Wealth and is a staple of their trading strategies.

Credit Spreads use 2 legs of options in a strategy wherein you sell an option to make money from the premium, and you also buy an option as a protection in case things don't turn out to be what you expect, and then pay an insurance fee for it. In this strategy, the premium you receive is always much greater than the insurance fee that you paid for, and the net amount is called the credit. Also, with this strategy, generally there is a difference or a spread between the strike price of your buy option and your sell option. Hence, it is called credit spreads.

There are 2 types of credit spreads:

• Bull Put Spread
• Bear Call Spread

Bull Put Spread

A Bull Put Spread is used when you have a bullish view of a particular stock. This strategy generally involves buying a Put at a lower strike price than the strike price of your Sell Put. For example:

You buy a Put of XYZ Corp at the strike price of $10.00 for March 09 for a fee of 10cents
You sell a Put of XYZ Corp at the strike price of $10.50 for March 09 for a premium of 25 cents

You then have a net of 15cents. If you stay on the trade, and the share price of XYZ Corp stays above $10.50, then you get to keep the 15 cents premium! Obviously, all these comes in lots of 1,000 per contract, so imagine if you had 20 contracts of these! That would be a potential profit of $3,000 out of a $10,000 risk! That is a good return on investment!

Bear Call Spread

A Bear Call Spread is the opposite of the Bull Put Spread in that this strategy is used if you have a bearish view of a particular stock or share. This involves buy a call at a higher strike price than the sell call for this share.

For example:
You buy Call option of XYZ Corp at the strike price of $15.00 for March 09 for a fee of 8cents
You sell Call option of XYZ Corp at the strike price of $14.50 for March 09 for a premium of 20cents

The result is a credit of 12 cents. If you stay on the trade, and the share price of XYZ Corp stays below $14.50, then you get to keep the 12 cents premium!

Obviously these are just examples, and you need to look at your charts and take a view on where the direction is for a specific share.

There is definitely more information on the e-books offered by Planet Wealth, and if you're serious with making money using this strategy, get your copy NOW! I can only say that it's been the best $99 investment I've made, and on my first month, I've already recovered it from my successful trade!

I hope this has been another beneficial post, and one that would encourage you to take the next step, if you haven't already done so.

Another sharemarket secret unveiled!