1. 20 Investments: Introduction
  2. 20 Investments: American Depository Receipt (ADR)
  3. 20 Investments: Annuity
  4. 20 Investments: Closed-End Investment Fund
  5. 20 Investments: Collectibles
  6. 20 Investments: Common Stock
  7. 20 Investments: Convertible Security
  8. 20 Investments: Corporate Bond
  9. 20 Investments: Futures Contract
  10. 20 Investments: Life Insurance
  11. 20 Investments: The Money Market
  12. 20 Investments: Mortgage-Backed Securities
  13. 20 Investments: Municipal Bonds
  14. 20 Investments: Mutual Funds
  15. 20 Investments: Options (Stocks)
  16. 20 Investments: Preferred Stock
  17. 20 Investments: Real Estate & Property
  18. 20 Investments: Real Estate Investment Trusts (REITs)
  19. 20 Investments: Treasuries
  20. 20 Investments: Unit Investment Trusts (UITs)
  21. 20 Investments: Zero-Coupon Securities
  22. 20 Investments: Conclusion

What Is It?
Options are a privilege sold by one party to another that offers the buyer the right to buy (call) or sell (put) a security at an agreed-upon price during a certain period of time or on a specific date.

There are two basic types of options: calls and puts.

A call gives the holder the right to buy an asset (usually stocks) at a certain price within a specific period of time. Buyers of calls hope that the stock will increase substantially before the option expires, so they can then buy and quickly resell the amount of stock specified in the contract, or merely be paid the difference in the stock price when they go to exercise the option.

A put gives the holder the right to sell an asset (usually stocks) at a certain price within a specific period of time. Puts are very similar to having a short position on a stock. Buyers of puts are betting that the price of the stock will fall before the option expires, thus enabling them to sell it at a price higher than its current market value and reap an instant profit.

The exercise or strike price of the option is what the stock price must pass (for calls) or go below (for puts) before options can be exercised for a profit. All of this must occur before the maturity date, also known as the expiration date. It should be noted that an option gives the holder the right, not the obligation, to do something. The holder is not required to exercise if he/she does not want to or if the terms are not favorable.

Objectives and Risks
For most options strategies, you need to have a very high risk tolerance; it is not uncommon for a stock option to fluctuate 30-40% or more in a single trading day.

The objectives of options are up to the holder. There are two types of people who use options: speculators and hedgers. Speculators simply buy an option because they think the stock will go either up or down over the next little while. Hedgers use options strategies - for example, the covered call, which allows them to reduce their risk and essentially lock-in the current market price of a security. Options (and futures) are popular with institutional investors because they allow institutions to control the amount of risk they are exposed to.

How To Buy or Sell It
Options trade very similarly to stocks and can be purchased through just about any discount or full-service broker. To trade options, you need to be approved by the brokerage first. They will typically ask questions to determine if you have enough knowledge or experience before they will approve you. Options are usually bought through a margin account, or borrowed money. (For a more in-depth look at options, see our Options Basics Tutorial.)




Strengths
  • Allow you to drastically increase your leverage in a stock if you are speculating.
  • Options in 100 shares will cost much less than actually buying the 100 shares.
  • If used properly, options can be a useful tool in hedging against an existing position.

  • Weaknesses
  • Options are highly complex and highly leveraged. If you are using options to speculate, you need to keep a close watch on them and to have a high tolerance for risk.
  • Options require more than just a basic knowledge of the stock market.
  • You have the potential to lose a lot of money if you take various positions - for e.g. if you are the writer of an option.

  • Two Main Uses
  • Capital Appreciation
  • Increase Leverage

  • 20 Investments: Preferred Stock
    Related Articles
    1. Investing

      Why Options Trading Is Not for the Faint of Heart

      Trading options is not easy and should only be done under the guidance of a professional.
    2. Trading

      Options Pricing

      Options are valued in a variety of different ways. Learn about how options are priced with this tutorial.
    3. Trading

      Three Ways to Profit Using Put Options

      A brief overview of how to profit from using put options in your portfolio.
    4. Trading

      Getting Acquainted With Options Trading

      Learn more about stock options, including some basic terminology and the source of profits.
    5. Trading

      Options Hazards That Can Bruise Your Portfolio

      Learn the top three risks and how they can affect you on either side of an options trade.
    6. Trading

      Stock Options: What's Price Got To Do With It?

      A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price.
    7. Trading

      A Guide Of Option Trading Strategies For Beginners

      Options offer alternative strategies for investors to profit from trading underlying securities, provided the beginner understands the pros and cons.
    Frequently Asked Questions
    1. How does the price of oil affect the stock market?

      Read about how the price of oil might impact the stock market and why economists have not been able to find a strong correlation ...
    2. What are the differences between gross profit and net income?

      Find out how companies determine gross profits and net income, and how these figures provide quick snapshots of their financial ...
    3. How does Twitter (TWTR) make money?

      Learn how Twitter earns revenue, including the company's use of three targeted advertising streams and data farming and licensing.
    4. I'm about to retire. If I pay off my mortgage with after-tax money I have saved, I can save 6.5%. Should I do this?

      Only you and your financial advisor, family, accountant, etc. can answer the "should I?" question because there are many ...
    Trading Center