How to Explain Stock Options
- 1). List reasons investors use stock options. One reason an investor may buy or sell options is that for the same amount of money it takes to trade shares of stocks, he can trade a larger number of option contracts. An investor can make more money trading options than trading stocks. With all stock options, there is a specific price at which the option is bought or sold and a specific date by which the option is exercised or acted upon. In exchange for getting the option, the investor makes a payment called a premium.
- 2). Point out where options are traded. Most stock option trading takes place on the open market. These options are listed on various options exchanges and, like stocks, have ticker symbols. In the United States, most option contracts consist of 100 shares of the underlying stock. Options are available on many stocks that are traded on the New York Stock Exchange (NYSE), the American Stock Exchange (AME) and the NASDAQ. There are two types of options, call options and put options and diverse ways to use puts and calls to make money.
- 3). Describe a call option. When you buy a call option you have the right to buy a specific number of contracts at a pre determined price (called the strike price) at any time before the option expires. You buy a call option if you think the price of the underlying stock will increase in value before the option expires. The price at which an investor buys an option is the exercise price. If the stock goes up in price and reaches the strike price at or before the expiration date, the investor makes a profit. If the stock does not reach the strike price, then the option expires and the investor loses only the premium or the money paid for the contract.
- 4). Describe a put option. A put option works similarly to a call option except with a put option you buy the right to sell an option contract at a specific price before the expiration date. Investors use put options when they believe the price of a stock will decrease. When the option expires at a lower price than the exercise price (or the amount paid for it), the investor makes a profit. The put option is worthless if it expires at a price that is above the exercise price and the investor only loses the premium paid.
- 5). Talk about how complicated and confusing stock options can be. The above explanation is a simplified version of stock option trading. Thee are really four types of options traders in the market---buyers of calls, buyers of puts, sellers of calls and sellers of puts. All are necessary to keep the options market functioning. There are also a wide variety of options available such as long calls, short calls, long puts and short puts. Stock option trading can be confusing to novices, so it is best left to experienced investors. A beginner can become a skilled option trader by educating himself with books and courses.
