Option Trading Training – make the move from gambling to sound investment

August 5, 2010 by  
Filed under Option Trading

You have probably heard of the idea of using ‘options’ in trading on the stock market, as one possible active strategy to use in preference to buy-and-hold. You have probably heard of the fact that option prices are much more volatile than share prices, and that you can buy and sell options without ever having to buy the shares themselves. If you are just starting your options trading training, you may not yet understand where these ‘options’ come from. If I buy a call option, I am agreeing with another party that I can choose to buy the corresponding shares from that party, at the agreed price, at any time up to the expiry date of the option. But, as in any deal, there are two sides to this trade. If I can buy the option from the other party, then he is selling the option to me. He can do this because he actually owns the corresponding shares, so he can supply the shares to me if I choose to exercise my option in the future. Why would he do this? Well, if I am buying the option because I have an expectation that the price is going to rise above the agreed option price (the ‘strike price’), then you can see that his expectation must be the opposite – that the actual price will remain below the strike price, in which case I am not going to exercise my right to buy at the strike price. So what? So, I paid him for the right to buy at the strike price – if I don’t exercise my right to buy, then he simply pockets the price I paid for the option, and it is pure profit to him. It’s a gamble for both sides – if the market price rises above the strike price, the buyer of the call option is in profit; if it doesn’t, the seller keeps the price paid for the option and he is in profit. But look – this ‘other party’ is not some special magic kind of dealer – he is just someone who owns the shares on which he is offering to sell an option. If you have a portfolio of shares, there is nothing to stop you offering to sell call options on your shares. You get an immediate payment for the option, and either you simply keep it, or you have a guaranteed sale price for your shares. As you might expect, there is a similar situation for put options – someone has to be selling the put options in order for you to be able to buy them. As a further variation, and somewhat more risky, you can sell an option for shares you do not currently own. This gets you an income from the sale in the short term, but if you are on the losing side of the gamble then you have to go and buy the shares at the current market price. As you go further into your options trading training, you will begin to understand the risks and benefits, and your trading will move from gambling to sound investment.

Bill Stewart is a work-at-home geek specialising in options trading. For tips and information visit Options Trading Training