What are Options and How Can You Profit From Them?

  •  
  •  
  •  
  •  

[wp_campaign_1]

The average investor has most likely never heard the word “option” when speaking of investments, or if they have, they most likely did not understand what it meant. Typically, people shove money into their 401(k) at work, or they buy a couple of stocks here and there. In either case, if the market goes up they are happy because they made money, and if the market goes down, they’re all grumbling because the value of their shares are now worth less than before.

What? You Can Make Money If The Market Goes Down?

I’m just guessing that everyone you know is watching for the market to go up. Wouldn’t it be odd if someone was rooting for it to go down? Well, this actually happens every day in the world of options. When investors predict that a particular stock will go down in value, they’ll buy a put option. If it does in fact happen, then they can profit from the loss on that stock!

Explanation of Options

There are two main types of options: put options and call options. Let’s dig into each of these and discover how to profit from them.

Call Option

A call option is simply a contract that gives the owner the right to buy shares at the current trading price. Typically, these contracts last for 30 days, so if you purchase a call option on 100 shares of stock that is currently valued at $50 and after 30 days its value has risen to $60, you just made yourself a cool $1,000. How do you do that? Well, you have the right to buy the shares at $50 on that 30th day, and since they are now valued at $60, you could turn around and sell them at the current market value and leave with an extra $10 per share, or $1,000 (minus what you paid for the call option of course).

What if the stock actually goes down? Well, then you simply lose the amount that you paid for the options. It’s as simple as that.

Put Option

For many people, put options are a little more difficult to understand. Instead of forming a contract where the investor has the right to buy shares at a particular price, a put option gives the investor the opportunity to sell shares at a particular price (even if they don’t own them).

Let’s say you think a stock is going down in value – you’d buy a put option because it will give you the right to sell the shares of stock at today’s price, even though the stock might have lower value in the future.

So, imagine that you do purchase your put option which gives you the right to sell 100 shares of stock at today’s value of $35. If the stock value takes a dive and ends up at $20 per share, you still have the right to sell your shares at $35. All you have to do is buy some stock at $20 and sell it at your agreed upon price of $35. This move just earned you $1,500 (minus your option contract expense).

What if the stock value went up? Well then, you guessed wrong on your put option and you lose the money that it cost to set up the contract.

If you are interested in investing with options, there is an OptionsXpress promo code which could earn you $100 at sign-up! Good luck with your investments and do so responsibly!

If you enjoyed this article, Get email updates (It’s Free!)


  •  
  •  
  •  
  •  
  •  
  •  
  •  

Money

Derek

AUTHOR Derek

My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.

4 Comments

  1. While the nearest month does tend to have the greatest number of open contracts, I wouldn’t say that call options tend to last for 30 days. There is a set schedule for when options can start being written, but there are many contracts available at various time intervals. For example, Intel has contracts expiring in Feb, Mar, Apr, May, Jul, Oct, Jan 2013, and Jan 2014, not to mention weekly options now.

    In fact, the time to expiration is a very important strategic entity when trading options which you don’t really want to screw up. It is better to purchase longer contracts and sell shorter.
    cashflowmantra recently posted..Ever Hear of Money Illusion?

    • Thanks for the clarification CFM! I know you are the options King, so I’ll definitely take what you say to be the truth!

    • Yeah, I’d say 13 years of experience is pretty solid. Thanks for the comments!


Add a Comment

Your email address will not be published. Required fields are marked *

CommentLuv badge

Related posts