First and foremost it’s vital to understand the different elements in the phrase ‘stock option trading’.
Stock – this is the value of a company’s assets and profits. They are represented by shares and show what a company is worth in the market place.
Option – an option is a contract which gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a set price within a pre-determined time frame.
Trading – when a buyer invests on the performance of an asset.
Stock option trading is when the underlying asset chosen for the option trade is stock.
So, whereas in traditional stock trading an owner is buying or selling actual shares in a company, in stock option trading the owner is purchasing the option i.e. he is entering into a contract to buy or sell stocks at a fixed price within a specified time frame. (see Option Trading).
How is a stock option trade carried out? Assume you’re the buyer:
1)Choose the company whose stock the contract will taken out on
2)Select the expiry time of the option – end of the hour, day, week or month
3)Decide which direction you think the stock will move in – if you think it will increase then purchase a Call option. If you think it will decrease then purchase a Put option
4)Enter an amount and purchase your option