Options Contract Trading Education

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By eHow Contributing Writer

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Options contract trading can be very successful if you have the right education and training. Though options trading is a sophisticated investment strategy and carries a high degree of risk in some cases, it is not necessarily very difficult to learn. The two types of options contract trading are stock option and futures options. The terminology is the same for both types, but the leverage is quite a bit different. While every stock option represents 100 shares of the underlying stock, futures options vary from commodity to commodity. For example, an option on coffee represents 37,500 pounds of coffee and an option on corn represents 5,000 bushels of corn.

Function

An option contract grants the option holder the right, but not the obligation, to purchase or sell a given stock or commodity at a fixed price for a predetermined period of time. Option prices are comprised of two elements: time value and intrinsic value. Time value is the arbitrary value of the remaining time before the option's expiration date. Intrinsic value is the difference in price between the current market price and the strike price of the option. For example, if XYZ is trading at $12 per share and the Investor has a $10 strike price on his call option, that option has $2 of intrinsic value. All stock options represent 100 shares of stock.

Types

The two types of options contracts are calls and puts. When an investor believes the price of a stock or commodity is going to rise in value, he would purchase a call option to take advantage of the upward move. Likewise, if he believes the price is going to decline in value, he would buy a put option to take advantage of the downward move in the price of the underlying security.

Time Frame

All options have an expiration date. Options are considered a wasting asset for this very reason. As the option draws nearer to its expiration date, its time value declines dramatically. If the option has no intrinsic value, it will waste away to nothing and expire worthless, causing a total loss for the option holder.

Considerations

Receiving the proper training before beginning to trade options can save an investor thousands of dollars in preventable losses. There are many options trading courses available online, and live courses are available in most major cities. Finally, there are many excellent books available on options trading, and many are written in easily understandable terminology.

Warning

Options trading carries a high, albeit well defined, degree of risk and is only appropriate for sophisticated investors. Investors must be approved to trade options by their brokerage firms by demonstrating a knowledge of the options market. It is critical to receive options contract trading education prior to entering the options trading arena.