I'm happy to announce a new series here on Investor Trip that's dedicated to stock option trading. What inspired me to learn more about option trading was the recent characteristics of the US stock market.
As the Dow Jones passed 13,000 points, I spent more time researching ways to make money from losses in the stock market (aka bearish trends). Investors can profit from downtrends in the stock market using two techniques: shorting stocks and trading put options. Borrowing shares is risky business; stocks options provide ample insurance on your long (or short) term investments.
So throughout the week, we'll discuss the basic of stock options, bullish and bearish strategies, and techniques that you use on a daily basis. To start off the series, here's the very basics on the two basic types of options and how they are purchased.
What Are Stock Options
Trading stock options gives you control over a vast amount of shares for a fraction of the cost. Each option is called a contract, and entitles the buyer to 100 shares of the underlying stock. So for every 1 contract, you have the right, but not the obligation, to purchase 100 shares of the underlying stock.
Options trade as related symbols to the stocks they control. For example, Countrywide Financial trades under CFC, and Countrywide Financial $30 strike puts trade under CFC QF. Most options incorporate the symbol of the underlying stock, along with additional letters for identification purchases.
Types of Options: Calls and Puts
There are two types of stock options:
Calls are bullish trading options that you can buy or sell (write) in the options market. You purchase calls when you believe the underlying stock is rising in value.
Puts are bearish trading options that you buy or sell in the options market. You purchase puts when you feel the underlying stock is declining in value.
What Are Strike Prices
A strike price is like a water market in a bucket. It's a fixed price level on the underlying stock. So if you bought 1 option contract of MSFT at a strike price of $30, you have the option to purchase shares of MSFT at $30 a share. The strike price also determines the value of the stock option. Depending on whether you trade calls or puts, the strike price determines whether your options are ITM (In-The-Money), ATM (at-the money), or OTM (out-the money).
More Lessons in this series: