What is a Stock Option?

If you are wondering what is a stock option, or what is option trading you have come to the right place. A stock option investment is unlike any other type of securities, it gives you the ability to make higher gains but also it comes with a much higher risk, and eventually all stock options expire.

To look at what an option is you have to know roughly what a stock is. If you don’t know what a stock is, I’ll explain it real fast. If you do already know what a stock is feel free to skip over the next paragraph and go directly to the “ what is a stock option “ section.

A stock is basically a share of a company. Stocks go up and down based on supply and demand. Investors can then make money by buying a stock at a low price and selling it at a higher price. As long as the company is still around the security will be as well.

What is a Stock Option

A stock option investment will give the buyer the right to buy or sell a given security at a given price. For example say stock XYZ is trading at $45 and you believe it will make a big move in the near future. One thing you can do is to buy the $45 call option 3 months away for say $3 and lock it in that price.

By doing so you have to right to buy the stock at $45 at any time before those 3 months are up.

Now why would you buy a stock option investment instead of buying the stock? Because you greatly leverage your money by doing so.

If the stock goes up to say $55 within those 3 months that would be a 22% gain in the stock (very nice). But the option would be worth at least $10, a 233% gain from the same move (unbelievable).

There are also put options that let you take advantage of the downside. A put option gives the buyer the right to sell a stock at a certain price. If you believed that XYZ was going to go down instead of up you could have bought the $45 put option 3 months out instead for $2.50.

If the stock went down to say $40 in that same time period your option would be worth at least $5 because you have the right to buy the stock at $40 and sell it at $45, making $5 instantly.

Stock Trading vs. Option Trading

While every trader is different trading stock options can often times lead to much greater gains and if used correctly can give off much less risk for traders who are typically in the market anywhere from a few days to a few months.

Of course the major advantage of options trading is that they allow investors to gain leverage. But they can also be looked at as less risky in some senses. In the above example if you bought stock XYZ for $45 you would be risking $45.

However if you bought the call option for $3 you would be able to benefit from roughly the same move as you would if you owned the stock while only risking 1/15th of what you would be, had you actually bought the stock.

What is a Stock Option and how to I Buy One?

Now that you know, what is a stock option and what is option trading you may be wondering, how to buy stock options. These can be bought through your broker just like stocks, however depending on your broker you may have to be authorizes to trade options.

In other words you need to have some experience in the stock market and you need to submit an application to trade options. Contact your broker for more information on this.

What is Stock Option Trading and What Should I know Beforehand?

Trading stock options does require you to be more disciplined then stocks because you cannot simply hold onto an option for the long term. If you do, eventually they will all expire worthless and you will be out of money.

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