Stock Options Trading

For many investors, stock options are regarded as a substitute financial instrument to buying the underlying stock itself. This is because investors can use also use stock options to bet on the movements of the stock’s price just like they are holding the actual stock itself.  Nevertheless, we have to take note that there are major differences between a stock and its option. One of the main differences is that when you purchase a stock, you owe a piece of the company which issue the stock. On the other hand, when you purchase a stock option, you are just given the ‘rights’ to buy or sell the stock of a company at a certain price. The question of ownership in a company does not arise with owning stock options.

Stock options come in two (2) forms, ‘Call’ options or ‘Put’ options. With ‘Call’ options , you possess the ‘rights’ but not the obligations to purchase a stock of a company at  particular price call the ‘strike’ price anytime before the stock option expire. Conversely, with ‘Put’ options, you have the rights to sell a stock at a strike price anytime before the expiration date. Take note that regardless of a call or put option, there is always a buyer and a seller for each option transaction.

As mentioned earlier, stocks are issued by the associated companies.  Options, however, are written by the market makers and have nothing to do with the associated companies or the options exchange. The price that investors pay for the stock option is known as the premium. The attractiveness of stock options for investors lies in the fact that their losses are limited to what they pay for the stock options if the price of the underlying stock moves against them. However, the potential profit for stock options are theoretical unlimited. Given the fact that the premium for a stock option is very much less than the cost of the actual stock itself, an investor will be able to leverage his capital more efficiently.

All stock options that are being traded are American style options. This mean that the rights of the stock option can be exercised anytime between its purchase date to its expiration date unlike European style options which can only be acted upon during its expiration date. When the call option’s strike price reaches a level that is ABOVE the market price of the stock, the call option is said to be ‘out of the money’. Conversely, if the strike price is BELOW the market price, the option is said to be ‘in the money’. The opposite is true for a Put option.

Stock options are usually transacted with strike prices at intervals of $2.50 until the prices reaches $30. Above a strike price of $30, they are traded at intervals of $5. In addition, what you find traded are those stock options whose strike prices are within a realistic range around the market price of the stock in question. Stock options which are far out of the money or far in the money are normally not available to be traded.  Another thing to note about trading stock options is their expiration date. Their expiration date can be up to nine (9) months from the date of issue. Officially, the expiration date is effected on the Saturday of the third (3rd) Friday of the expiration month. Hence, you have to exercise or trade the stock options on the third (3rd) Friday as it is unlikely that your broker will be available on a weekend.

Share

Related posts:

  1. Forex Options Trading
  2. Stock Options
  3. An Introduction to Options Trading
  4. Options Trading Types
  5. Binary Options Trading Glossary