How To Do Options Trading

One of the first words of wisdom I ever heard was the following. "Two out of three people make money in options: the broker and the specialist." What this really means is that you are the third person and the odd one out. Options trading can basically be looked at in two ways: either you are a speculator in the markets, or you are using options in a strategic way. The latter type of trading would encompass such trading strategies such as covered calls, time spreads, or hedging.

Covered calls are really the most basic type of trading for the novice. There are a couple of reasons for you to pursue this option. First and foremost would be if you were in need of some income on your portfolio. The buyer of the call will pay you a premium, or a dollar amount. This money is yours and you never have to give it back. The only drawback to this is the fact that if the stock makes a large upward move you will most likely not benefit from most of it. When the price of the stock goes above the price of the call you sold, you will lose your stock.

The second reason you may employ this strategy is if you are willing to sell your stock at a specific price. Instead of just putting a limit order to sell, you could sell the same covered call at the price for which you were looking to sell your stock, and receive the premium. The worst case scenario is that you sell your stock at the given price. The advantage to this, though, is the fact that you brought in some other money as a bonus in the meantime. Using options as a hedge is another strategy that makes a lot of sense, but most investors are wary to spend the money in this way.

Purchasing puts on your portfolio protects you against the downsides of the market. As markets retreat, the puts you have purchased on the stocks you own, or a benchmark such as the S & P 500, will increase in value, thus softening the overall losses in the portfolio. You can look at this as nothing more than buying insurance on an expensive car. Yet many investors drive portfolios worth hundreds of thousands of dollars with no insurance - this really makes little sense.

There are numerous ways to use options and there are many benefits that can be derived in this way. But be careful and try not let impulse drive your decisions.


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