Can You Make Money Trading Options?
Options are a legal contract to buy or sell 100 shares of a stock at a specific price at a specified future time. A call option is a contract to buy 100 shares and a put option is a contract to sell 100 shares. Options are a way to invest in stocks that gives you greater leverage than simply buying shares of a company. However, options are also more risky because, unlike shares, they are time-limited.
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Option Strike Price and Expiration Date
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The amount you pay for an option is determined by the strike price and the expiration date. If you are buying a call option with an in-the-money strike price (below the current price of the stock) and a long expiration date, it will be relatively expensive compared to an out-of-the-money call option (above the current price of the stock) with a short expiration date.
Call Option Example
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The owner of a call option makes a profit if the price of the stock rises above the strike price before the expiration date. For example, a call option with a $9 strike price that expires in six months for a stock currently trading at $10 might cost $300, but a call option with a strike price of $11 that expires in one month on that same stock might only cost $50. In the first case, the buyer of the call could sell it for around $400 if the price went up $2 or sell it for $100 even if the price of the stock did not go up over the entire six months. In the second case the call will expire worthless unless the stock moves up to $11 (the strike price) or more within one month.
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Put Option Example
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A put option is the opposite of call option, and the owner of a put option will make profits if the price of the stock goes down. For example, it might cost you $100 to buy an out-of-the-money put option at a strike price of $10 that expires in three months for a stock that is currently trading at $11. If the stock price goes down to $8 within three months, you could then sell the put for around $250, more than doubling your money although the stock was only down 27 percent.
Premium and Option Strategies
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The amount of money you have to pay for the amount of time before the option expires is called a "premium," and the greater the amount of time the higher the premium. There are even special types of options called "leaps" that do not expire for one or two years. The premium plus the difference between the strike price and the current price is how much the option will cost to buy. This price, of course, changes constantly as the price of the underlying stock changes. Many people buy short-term options when they expect big news from a stock in the near future, such as good news like a great quarter of sales or bad news like a drug failing in a clinical trial. This allows investors to profit from the leverage offered by options.
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