What are Stock Options
What are Options?
First let’s discuss what Stock Options are.
Options are securities that give the investor the right to purchase a stock at a specific price up until a particular date.
Stock Options are traded just like stocks. You can buy options for most stocks that are traded.
Options trading allows the investor to leverage their capital. For example, instead of actually purchasing 1000 shares of a $100 stock, you might be able to buy an option that allows you to buy that same stock for $105 the next few months at maybe only $1 per contract. 1 Option contract entitles the holder of the option to buy 100 shares of the stock. Therefore, in order to purchase 1000 shares of a given stock, you would need to purchase 10 options. In this example, instead of investing $100,000 to purchase the stock directly, you would only have to spend $1,000 to buy 10 options (10 options x $1 per option x 100 shares per option = $1000).
If the stock goes up in that timeframe, you would make approximately $1,000 for each $1 point move above $105. Conversely, if the stock never gets to the $105 per share or goes down below $100, you would loose some or all of the $1,000 you paid for the options, since they would expire worthless.
Option Trading can be very risky, but it can also be used to hedge risk. Let us say you have a portfolio of stocks, and you feel that there is a lot of risk that the market will go down, but you do not wish to sell your stocks just yet. You can buy an option called a “Put” on the S&P 500 Index,. which will go up if the stock market goes down. So in this case, Option Trading is a form of portfolio insurance. So when the market is down trending, the S&P should also goes down, generating profits on your S&P 500 Puts that offset losses in your portfolio.
For the best information available on options, go to www.CBOE.com. That is the site of the Chicago Board of Option Exchange in Chicago. They are the home of most of the options trading in the U.S. and an authority of this subject.
For information on a variety of Investment topcis, go to www.investorsmarts.com
