What's So Exciting About Stock Option Trading?

Option Trading seems to be more popular now than ever before. We all know that options can help leverage the money that you trade or invest. But, for the beginning stock trader, the concept of options trading can be a little confusing. In this article, I will to talk about what options are and the different types of options. I will also show the advantage that the options trader could have over people who do not trade options.Options can be broken down into two broad and general categories. There are call options and put options. The decision as to whether or not you want to use call or put options in your option trading depends on your opinion about where the market will go and how you want to make money based on that opinion.

One of the initial concepts that traders seem to find confusing is how options are priced. Usually, when people see the price of an option, it can be anywhere from a few cents to a couple of dollars. But, since a stock option represents 100 shares of the stock, the actual price that the trader will pay for an option has to be multiplied by 100. So, in option trading, a stock option that is priced at $.25 will actually cost $25 to purchase.A call option is the right but not the obligation to purchase a specific stock at a certain price for specific duration of time. This allows a trader to purchase the right to buy 100 shares at the strike price of the option before the option expires. So, if you purchased an XYZ $50 call option that expires next month, you have purchase the right to buy 100 shares of XYZ stock at $50 before the option expires next month. These expiration cycles are normal to option trading.

Some traders don't see the advantages that others do in option trading until they do the math. Let's suppose you purchase the above option for $.50. Since you purchase the stock option for $.50 and have the right to buy the stock and $50, you need the stock to trade above $50.50 in order to make money. This is called your breakeven price.Let's suppose that you check the stock price of XYZ stock and it's trading at $52. In order to calculate how much profit we would have on this trade at this price, you simply subtract the current stock price from the breakeven price. So, in this case you, would have profited $1.50. And, since options are traded in hundred share lots, this would translate to $150 profit. While this may not seem like a lot of money, keep in mind that in order to initiate this trade you only had to purchase the option for $50.

In the above scenario, the trader made money when the stock went up. Can we employ our option trading skills when the market goes down? You bet we can. If you are just looking to purchase options, this type of option trading strategy would employ put options.A put option is the right but not the obligation to sell a stock to someone at a specific price before a definite period in time. So, traders speculating that a stock may go down would purchase a put option. Let's clarify this with an example.

Let's say that you expect that ABC stock will go down. With this in mind, you purchase the ABC $25 put option for $.75. Now, remember that the stock will need to be below our breakeven price in order for us to make money. In order to calculate the breakeven for this trade we would need to subtract $.75 from $25. So, once the stock begins trading below $24.25 you will be making money.Option trading is not as confusing as some traders make it out to be. The concept of purchasing calls and puts are relatively straightforward and simple. As we have seen, the leverage potential and limited risk features found in trading options can be very attractive. For some traders, these are the two reasons that they get excited about stock option trading.

Understanding Options and How to Trade Them

In this article I want to describe the basics of options: what they are and how one can trade them.Options trading is extremely popular and provides far greater possible returns than does trading in the underlying stocks. But it also carries more risk.So it is extremely important to understand how options work as financial instruments and be clear on what your potential risk and rewards are in trading them.

Options are contracts on some underlying trading instrument - shares of stock, bonds, a commodity, even a mortgage loan! Stock options are the ones most people are familiar with and are the most traded by individual investors.But regardless of what the option is on, there are common features. One of the most basic is the contract feature specifying what the option owner has actually contracted for.There are two types of Option Contracts: CALLs and PUTs.CALLsA 'call' confers on the (option) contract holder the right to buy an asset at a stated price on or before a specified expiration date. An option to buy, but not an obligation. That's why it's called an option!The owner also has the option to let his contract expire. But then he loses everything he invested in buying that contract.

Essentially, when buying a Call option, you are betting that the underlying asset will increase in price before the expiration date. And, not only rise, but rise enough to make a profit.But whether you make a profit is determined by the price you paid for the option, and the increase in price of the underlying asset. Clearly the price must rise enough to cover the difference between the market price and the price at which you can buy the security (the strike price of the option contract). And, since the option itself has a cost, the price has to rise enough to cover that additional amount. That cost is called 'the premium'.

The cost of the option fluctuates with the supply and demand for that contract on the open market. Several factors determine the premium, including the price of the underlying asset, the strike price of the option, the time remaining on the option, and others.The time remaining is particularly important. Naturally as the option contract nears its expiry date the price of the underlying asset (the stock for example) is less likely to change dramatically from its current price. Therefore the result of excersizing the option is known with more certainty and the cost of the option reflects that outcome. For example, if a Call option is nearing its expiry date and the value of the underlying asset is lower than the strike price of the option the option is practically worthless, and so its cost will be very low.

Suppose it's June 1, for example, and Intel (INTC) has a market price of $27. Call options for Sept 30 are selling for $3 with a strike price of $30. You buy one contract for 100 shares.So, if you held until expiration you either lose $300 ($3 x 100, the initial price of the contract not including commission), or buy the underlying stock at $30. If the current market price were $35 you've made $200. ($35 - ($30+$3) = $2 per share x 100 shares, ignoring commissions.)When the market price of a share is above the strike price, the option holder is 'in the money'. If the market price is lower, he's 'out of the money'

PUTs

A 'put', by contrast, gives the option buyer the option to sell an asset at a certain price by a stated date. The option, not the obligation.Puts are similar to 'shorting stock', in this sense. Put buyers are betting the stock price will fall before the option expires. In this case the market price must fall below the strike price in order to garner a profit from exercising the option. (Ignoring the cost of the put, for simplicity.) Under those circumstances, the option holder is 'in the money'.

For example, take the same situation as above but let the option be a put. If the market price falls to, say $25, your profit would be:

First, $3 x 100 = $300 = Cost of put, excluding commissions

Then, buy 100 shares at $25 per share = $2,500 to repay broker 'loan' (since shorting stock involves borrowing shares you don't own, then repaying later).

Finally, sell 100 shares at Strike price = $30, 100 x $30 = $3,000

Therefore, your profit = ($3000 - $2500) - ($300) = $200.

(Actually, the broker takes care of all the underlying mechanics. The investor merely orders the trades at a given time and date.)Whether investing in calls or puts, wise investors do need to do their needed homework. Options trading is risky and somewhat more complicated than simple stock trading. But it can be extremely lucrative!

Making Money From Option Trading With Implied Volatility

Option trading remains a mystery to many new traders. There are elements to option trading that traders should know about to make trading easier. In this article, I give an example of how an options trader might use implied volatility in his trading. Then, I discuss implied volatility charts and how they are created.There is a definite connection between time value and volatility. As an option moves further away from its strike price time value decreases. Since the option has less time value, it will also have lower implied volatility. In making this observation, we can see the link between the volatility and time value. Once we understand this relationship, we can use this to our advantage in our option trading. So, let's look at an example of how this might be useful.

Let's suppose that we have a calendar spread on XYZ stock. To create the spread, we sold the December 50 call for $2.00 and purchased the March 50 call for $4.50 when the stock was at $50. The net result is a debit of $2.50 to our account. Typically, traders like to place his type of trade when the volatility in the options sold is higher than the volatility of the options purchased. All things being equal, this lets them know that they are selling more time value than they are purchasing. Traders sometimes refer to this as volatility skew.Now, let's say that after we place our calendar spread the stock begins to move up. As it does, the intrinsic value of our options increase and the time value of our options decrease. So, let's say that we have about two weeks left before the December 50 call options expire and the stock has moved up to $55. The December 50 call options are trading for $5.75. This means that the time value of this option has decreased by $1.25 while the intrinsic value has increased five dollars.

If we allow the December 50 call option to remain in the money, it is likely that we will be exercised at options expiration. Also, as the option's time value continues to decrease, it also increases the likelihood that the option will be exercised. In order to prevent this from happening, the trader could purchase the December 50 call option initially sold while selling an option with more time value. Suppose the trader purchases the December 50 call option for $5.75 and sells the February 55 call option for $5.70. The result is a net debit to the account of five cents. So, we collected $1.25 of time value on the December 50 calls and sold an additional $5.70 worth of time premium when we sold the February 55 call options. This means that we collected a total of $6.95 of time premium. As with the options example from last week, this was accomplished by covering the option after its time value and volatility had decreased due to market movement and selling an option that has more time value and higher volatility.

Implied Volatility charts

Novice traders sometimes look at implied volatility charts without really understanding how they are created. This usually comes to light as they begin to realize that volatility can be calculated for any option. And, the volatility value will likely be different for each option. So, if this is the case, where does the implied volatility value come from that is used to create these charts?Typically, implied volatility charts are created by using options which are at the money and will expire within the next 30 days. So if we look at the last point on a implied volatility chart, the volatility value would be derived from the option that was at the money as of the close of the trading day.

For example, let's suppose that we are looking at an volatility chart for XYZ Company. Today XYZ Company closed at $25. If we use and options pricing model on the $25 option, we can derive the volatility. If we do this every day, we can create a chart of daily implied volatility.A good understanding of volatility is important to option trading. Seasoned options traders understand how to use implied volatility to consistently make money. Once you understand what it is and how to use in option trading, you can take steps to place the odds of making money in your favor.

Trading Systems - What You Need To Know Before You Buy One

When traders contemplate purchasing a new trading system for stock market trading, they typically don't consider the cost of ownership. But, there are many things that new traders should consider when purchasing a new piece of software like the cost of maintaining the software and the cost of the data the program will need to function. In this article, I will mention some of the additional cost that traders should consider before making the decision to purchase a new trading system for stock market trading.The cost of owning a trading system or charting package for trading the stock market can be very high. Several factors come into play when looking at the overall cost like the type of market you trade and whether or not you intend to use end of day or real-time data. A stock market trader who is looking to trade stocks real-time versus end of day could find their data costing as much as 200% more than the typical end of day data service.

The format of the data can make a difference too. A program that requires a specific data format can be more expensive to own. Two common formats of data for trading software are Metastock and ASCII. There are pros and cons of using both. But since these are among the industry standards for data format, and makes data vendors more plentiful and there is more competition. Obviously, it is this competition the keys the cost down.When the trader considers a real-time service they can end up paying much more. However, the cost may be justified depending on how frequent the trader trades and the type of market he trades. A trader who trades in markets such as futures can experience a good deal of volatility and therefore they may want to have a real-time service where they can see the fluctuations of volatility that occur during the day in the charts of their trading.

An alternative to a real-time service is a delayed service. A service that delivers delayed quotes can cut the cost of the data by as much as 80% from the real-time counterpart. This can make a huge difference for traders to or just starting out and may want to use the money to trade rather than pay for real-time data. The cost of owning a trading system can be pretty steep for beginners and professionals alike regardless of whether or not you are interested in stock market trading or some other market. When considering the purchase of a new system, traders should take the cost of their data feed into account. This sets their foot firmly on the path of treating trading less like a hobby and more like a business.

Why Invest in Commodities?

Most of us are quite comfortable with investing in cash deposits, government bonds, and stocks for conservative risk-averse investors. We hear these products discussed widely in the financial media. But rarely do we hear commodities discussed as an investment alternative. After all, what do commodities have to offer that stocks haven't already provided? Here are reasons why commodities can be a good investment: - By diversifying your portfolio, the risk can be reduced, especially during recessionary periods such as bear markets where stocks tend to decline and lose value. Commodities tend to rise and this would counter the loss of portfolio value.

Commodities trend better than stocks, not only on individual or also stock sectors and stock indexes. As such they are a better long-term investment vehicle. Trends tend to last short term such as a few months to a few years. When the trend begins, it is very unlikely there will be sharp reversals or unpleasant surprise.- Commodity markets have large liquidity. Not all stocks are liquid even if they look very attractive earnings-wise, but exiting can be a painful process. In commodities, all commodities traded are highly liquid. - Commodities have been trading for more than a century. More than 90% of stocks come and go. None are changed any way so there is more reliability in back-testing (review your strategy on past historical data) than others instruments such as futures and stocks where premiums change from one expiring contract to a new one, or stock-splits.

- At tax time, profits from commodities pay lower taxes than profits from stocks. In addition, there is no need to itemize all the transactions line by line where all stock transactions must be itemized. Long term or short term capital gains do not apply in commodities.- Due to leverage, the gains can be spectacular, possibly many multiples of the original equity. For a small sum in the account, it is possible to more than double the account equity in a very short period of time.- If the financial objective of the person is aggressive where he has high tolerance for risk, then commodities may fit is personal tolerance for risk. With a small equity, he can use for high-growth part of the entire diversified portfolio.

Here are some reasons against the investing in commodities:

- Daily Price Limit can prevent the investor from exiting a position if prices have reaches the day's maximum price rise or decline allowed. This is especially difficult when his position is in a loss. Many times, margin calls will automatically exit the position. However, the account can be in the negative where the investor must fund additional money to the account to get back in black.- There is lack of research materials covered in the media or in print compared to those covering stocks. The most popular financial books mainly use stocks as examples. Most brokerages and investment banks whose analysts cover industries and stocks. Investors like to see easily available and up-to-the-minute information which can be made available but not in a wide variety.

- The leverage is high, so small losses can make a big impact on the equity. This is a common scenario where the uninitiated and unprepared will see the account being wiped out.- Future contracts constantly expire. If it's a long-term holding, contracts must be managed properly changing to forward contracts. This can be tricky because premiums change from one forward contract to the next. Acute attention must be given in doing so.If the investor is risk-averse in which he is content with small return year to year, then commodities might not be the right investment.

This list should not be considered final for any person to decide if he or she should trade commodities. There are many other factors and priorities, such as financial situation, time and preparation of each person to commit before deciding. To effectively profit from any market, due diligence and preparedness is the method to obtain the desired objectives. Weigh each pro and con carefully and verify the arguments for oneself before committing hard-earned money to waste.