Ways to Trade Options
Options are short term securities that trade against the value of an underlying security, such as a stock share price or index value. The large number of available options on a wide range of securities allows traders to set up trading strategies ranging from conservative to aggressive.
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Option Strategies and Combinations
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Options contracts are available that go up with a stock price -- call options -- or go up when the stock price declines -- put options. Each optionable security has option trading with several expiration months and strike prices above and below the current security price. Traders can have strategies of buying or selling a single option to meet their trading goal or put together strategies of buying, selling, different strike prices and/or expiration dates to profit if the underlying security goes up, down or sideways. The TradeKing Options Playbook lists 37 different strategies using a combination of option contracts.
Speculation
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Options allow traders the possibility of large profits with lower dollar amounts at risk. A trader can purchase call options on stocks she believes will go up or put options on stocks expected to decline. The challenge of this type of option trading is research for stocks expected to experience large price moves before the option expiration date. The risk for the trader is 100 percent loss of the price paid for the options. Option contracts typically cost from less than $100 to a few hundred dollars per contract. If the underlying stock price moves to a profit position for the options, each option contract will earn $100 in profit for every $1 change in the underlying stock price.
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Income Generation
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Trading strategies that involve the selling of option contracts can generate a stream of income for a trader. Income generation option strategies include covered calls, cash secured puts and naked short put and/or calls. Option sellers receive the premiums from option buyers and must fulfill the contract if the buyer elects to exercise the option. Option sellers look for contracts that should not result in profits for the option buyer, such as selling call options on stocks that decline or put options on stocks that increase in price.
Trading the Greeks
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Theoretical option prices can be computed with mathematical models which consider the volatility of the underlying stock and time until an option expires. The mathematical expectations for option prices over time are defined with the Greek alphabet. The Greeks -- Beta, Delta, Gamma, Lambda and a few more are calculated to determine if the supply and demand forces of the market are correctly pricing or mispricing option contracts. Greek traders look for options which vary from the model predictions and set up combinations to profit from the market force corrections that should occur.
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