The buyer of a put option makes a profit if the price falls below the strike price before maturity. The exact amount of profit depends on the difference between the stock price and the option strike price at expiry or when the option position is closed. This strategy is the other side of long selling, but here the trader sells a put option called a “short sell” and expects the stock price to be above the strike price at maturity. In exchange for selling a put option, the trader receives a cash premium, which is the most a short sale can earn.
If the stock closes below the strike price at the expiry of the option, the trader must buy it at the strike price. Call options are “in the money” when the stock price is above the strike price at expiry. The owner of the call can exercise the option, putting cash to buy the shares at the strike price. Or the owner can simply sell the option at its fair market value to another buyer before it expires.
There are many factors that influence the price of an option. A trader can't just buy calls and expect to make money when the stock price goes up. The problem is that new traders are unaware of all the other factors that affect whether the trade will make a profit or lose money. THE ONLY WAY TO LOSE MORE MONEY ON YOUR OPTION THAN YOU ORIGINALLY INVESTED IS IF YOU SHORTED (WROTE) AN OPTION AND THE MARKET TURNED AGAINST YOU.
Before buying or selling options, investors should read the Characteristics and Risks of Standardized Options brochure (PDF 17.8 MB), also known as an option disclosure document. Deciding how much to pay for options requires some trading experience, but you need to consider several points. Fortunately, Investopedia has created a list of the best online brokers for options trading to facilitate the first steps. Trading during the earnings season usually means you'll find greater volatility with the underlying stocks and will typically pay an inflated price for the option.
Most brokers assign different levels of option trading approval depending on the risk involved and the complexity involved. The good thing about hedged buying as a strategy is that the risk doesn't come from selling the option when the option is hedged by a stock position. Prior to joining Ally, Brian was a senior personnel instructor for the Chicago Board Options Exchange (CBOE) and led the training department of one of the world's largest market makers, Knight Trading Group. Options are essentially leveraged instruments, as they allow traders to amplify the potential upside profit by using smaller amounts than would be needed if they were to trade the underlying asset itself.
Buying OTM call options seems like a good starting point for new option traders because they are low-cost. Brokerage customers will normally have to be approved to trade options up to a certain level and maintain a margin account. If you plan to buy an option during earnings season, an alternative is to buy one option and sell another, which creates a spread. And you won't be able to force the trade unless you offer to buy back short options at a price that makes it worthwhile for the jerk on the other side.
Holding shares turns a potentially risky trade, the short buy, into a relatively safe trade that can generate income. They want to make sure you have enough investing or trading experience to hopefully make good choices when it comes to options. .
