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Options Trading - What You Need To Know About Trading Options

Aug 17, 2007
What is options trading? Well quite simply, with options trading, the taker (or buyer) is buying a right to do something from the writer (or seller). There are different types of options trading, with stock options and commodity options being the most commonly used. Options trading can be used in any market where the prices of items fluctuate; this will in reality include all markets.

So how exactly does an option work? Well suppose the price of a share is $10 today. You think the price of the share is going to increase to $12 over the next month. A great idea in this situation would be to buy lots of the shares. However, you are not always in a position to buy such shares, and often you will not have enough money to buy too many of them. In this example, if you had $1000 you could only buy 100 shares. This means you would gain $200 if the price went up as you are hoping. This is not a bad return but you may be wishing to make a bit more than $200 on the information you have.

With options trading, you can pay a premium to a writer for an option. Supposing the writer believes the price of the share is going to stay the same over the next month, that is stay at $10. Then if you offer him 10 cents a share, for an option to buy the shares at $10 in a month's time, he should be willing. After all, he thinks they'll still be worth $10 so he'll be making 10 cents a share on shares he doesn't even own, and all he has to do is sell them to you at their current price in a month's time, if you want them.

At ten cents a share, your $1000 could buy you an option to buy 10,000 shares. Now if the price goes up to $12, you will immediately have a $2000 gain. This is because you have an option to buy them for $10,000 and can immediately sell them for $12,000. Instead of a 20% gain, you've made a 100% gain. This is how options trading can work to your advantage. However, you can lose big with options trading. Suppose the shares dropped to $9.90. This is a small drop but instead of losing $10, if you had bought the shares, you will have lost your entire bet.
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