Trading options is one way for the novice investor to get their feet wet in the market because they offer less risk at a lower cost than buying traditional stock.
Options come in two forms: call options and put options. Though different in function, it is important to know that buying options gives you the right to exercise the option, while selling options obligates you to follow through in the event the purchaser exercises the option.
Buying Call Options
Call options are what you buy when you believe a stock is going to increase in value. In exchange for the price of the option, you lock in a set buy price for a particular stock. If the stock exceeds your buy price plus the option price and you exercise the option, then you make a profit.
Buying Put Options
In contrast to the call option, put options are what you buy when you believe a stock's price will fall. The option fee guarantees you a set price at which to sell the stock, no matter how far it drops.
Selling Call Options
Selling call options is similar to buying put options because in both cases, you believe the underlying stock's value will decline. As long as you own the underlying stock, the main risk is not reaping the profit associated with a climbing stock price.
Selling Put Options
Selling put options makes sense when you believe a stock's price will rise as you set the exercise price lower than the current market value. The risk in doing this is the obligation to purchase a stock that might become worthless.