Trading Options Notes

You can limit your potential financial losses while maximizing your potential gains by trading options in the place of stocks and futures. New, revolutionary approaches to stock option trading strategy even include the capability of defining stock option expiration dates as well as the maximum losses that you can accept from any one element of your investment portfolio.

The term 'trading options' describes contracts which provide the purchaser the right to buy or sell financial securities, such as stocks, with a specific timeframe and for a particular price. Before jumping into the trade of stock options, it is wise to educate yourself regarding the various option types, their risks, and the basic option strategies involved.

It is important to determine why stock options act in a certain manner. Can one determine its sensitivity to gains or losses in the underlying stock? How many different pricing models exist? Will changes in the overall market affect any positions you hold? Understanding the fundamentals behind how options behave is important so that you can then leverage this knowledge to gain new opportunities to trade. Many successful options traders have never figured this out but can still make money.

The price stock options consist of intrinsic value as well as extrinsic value. You also know by now through the Options Trading Basics guide that the intrinsic value depends on where the strike price is in relation to the price of the underlying stock. However, what you do not know is how extrinsic value is priced. How does the market come up with a justification for the risk taken by the writer of an option which is determined by the extrinsic value?

Indeed, if you're to give someone the option to sell or buy stock, you'd certainly think about a lot of factors to justify the risk you're undertaking; such justifications may include how much of your own assets are locked up in order to meet the requirements of the options contract, how much that stock is expected to move, when the options contract will expire, and much more–right?

The academic community has labored for years to try to determine a fair, acceptable, comprehensive mathematical model to price stock options so as to take each of these factors into consideration. You may use options trading strategies for bigger profits and safer investing.

The options trade has a number of advantages. First of all, trading options lets you decide your maximum loss before you even start trading. Options also allow you to specify where you believe the underlying stock will be trading on the date of its expiration. This is an innovative option trading strategy, and a wonderful new way to approach the markets. Before diving in, you should first educate yourself about how basic option strategies work, the various types, and the risk involved. As with so many other things in life, the more educated you are, the less risk you take.

- David Baxwell