Options Trading: Increase Your Reward with Less Money

Believe it or not, there are other trading options beside just the traditional stocks and bonds. One of the popular ones that is often somewhat of a mystery for average investors is something known as stock options (I started to learn options trading not long ago).

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What Are Stock Options

Stock options are traded in a separate market from that of the usual stock trading market. You don’t have to have as much money in order to buy and sell stock options than you would compared to just buying the stock itself. Essentially, a stock option is a secondary bet on the movement of a particular stock. With a stock option you are buying a contract from someone who holds the actual stock of a company. This contract gives you the right to buy (or sell) the underlying stock at a particular price at a particular time in the future. This particular price is known as the strike price while the particular time is known as the expiration date.

How Options Trading Works

The purpose of buying stock options is to put a smaller amount of money at risk in order to try to earn more money based on a correct prediction about a stock price movement. An example of how this might work is as follows:

You see a stock that is trading at $50 per share. You believe that the stock will trade up in the next 6 months, however you do not have a lot of money sitting around in order to buy many shares of the stock. However, you take a look at the stock options available on this stock. The current month is January, so you look at the options that will be expiring in July (6 months in the future). You decide that you want to buy some $55 strike options in order to try to profit from the upward movement that you believe the stock is bound to take. The reason for buying the $55 strike option instead of a $50 strike option is because it will be less expensive. The $55 strike option may trade at $0.25. This means that you will pay $25 for one option. This one option represents 100 shares of the stock. When you buy a contract for one option, you are buying a contract for 100 shares of the stock at the designated price and at the designated time.

As you can probably see, there is no point to exercising the option if the stock price does not reach your $55 target by July. However, if the stock does go above that price (say $56 per share), then you may be able to sell your options for $1 (representing 100 shares = $100). This is a $75 profit for you and you have increased your money four fold. If the price does not reach your $55 target, then you lose all of the money that you have invested in the options. Essentially, it is an all or nothing wager.

Is Options Trading for You?

Stock options are popular for those who do not have tons of money to play around with but at the same time would like to make some large returns. These options are also very complicated (as you can probably tell), and thus it is not wise to jump into this market without doing your proper research. The best way to do your proper research on this topic is to pick up some literature on the topic. Some of the best things that you can read on the topic are financial magazines and some financial websites on the topic. You will want to go with ones that will be easy enough for the average person to understand. Some of these would be money magazine and the finance section of msn.com. These two resources alone are a wealth of knowledge for learning the basic lessons in stock options.

If you are interested in trying to generate some large returns for small amounts of money, then you should begin the research today. You are also going to want to look up the stocks that you are interested in trading options in as well before you begin. Typically this list of stocks would probably include stocks that represent companies that you are familiar with. This will make it easier for you to track the progress of the companies that you are buying options in. Companies that affect your day to day life are a great place to start your options trading career. It is advisable to start with very small amounts of money on options that you feel very confident about. Make sure that the amount that you invest in options in the very beginning is nothing that you will miss. That is to say money that you are willing to throw away, because that may be what you are very well doing when you just get started.

Discount Brokers for Options Trading

There are a number of discount brokers that you can choose from for your options trading. Some of the best areĀ TradeKing and OptionsHouse. These two are the best in breed for different reasons. TradeKing is great for options research. They have a number of tools designed for specifically for and by traders to help out beginners and advanced traders alike. They offer reasonable prices ($4.95 + $0.50/contract) and a great trading platform. They are certainly worthy of your account. OptionsHouse is also a good choice for your money. They offer some of the best prices in the industry and they have lightening fast order executions. This means that they will be able to complete your trade faster than most brokers most of the time. This kind of service is critical in today’s market.

When you begin your career in the exciting market of options, make sure that you do proper research and take proper precautions to not lose too much of your money. With time and experience, you may find that you be able to make great amounts of money in short amounts of time :)

Photo credit: amanda b

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3 Responses to “Options Trading: Increase Your Reward with Less Money”

  1. Andy |  Jul 30, 2010 at 9:13 pm

    Thanks for this article – good basic summary of options. A little too risky for me, but good to know about different investment options (ha).

  2. Jimmy |  Jul 31, 2010 at 8:26 am

    great post…I’ve been itching to get into options and love the potential to make a lot of money, even if it does come with substantial risks.

  3. Mitchell |  Jan 11, 2011 at 3:40 pm

    What if I buy the option contract in january with a strike price of $55 for .25 a contract, could I sell the contract in april if the stock is $54?