How to Successfully Trade Stock Options in Ten Easy Steps - Step 1

The amount of stock options being traded in America is exploding! This is great news because there is far greater liquidity in the options market and many more money making opportunities for individual traders just like you. During the next ten weeks I will be writing articles on how you can profit from one of the fastest growing areas of financial investment available to individuals.

In case you don't know what a stock option is let me explain. Simply, a stock option gives you the right to control the ownership of a stock for a fraction of the price to buy it. There are two types of options; the first is a Call Option which is the option to buy a share of a certain company for a predetermined price before a predetermined date. The second is a Put Option, which is the option to sell a share of a certain company for a predetermined price before a predetermined date.

For example if you purchased 100 shares in ABC Company that traded at $50 each, you would have to invest $5000 to buy those shares. However you could buy 100 Call Options priced at $5 each, with the right to buy ABC Company at $50 any time up to a date in the future (say November 16th) and you would control the same amount of shares for only $500. If the price of ABC Company goes up by $5 and you owned the shares you would have made $500 or 10% on your $5000 investment, however because the Call Options give you the right to buy the shares at $50 and they are now worth $55 the price of the options would go up $5 as well and you would have made $500 or 100% on your $500 investment. This example demonstrates the great leverage stock options provide.

Call Options are used when you expect the price of a stock to rise, if you expect the price of a stock to fall you can buy Put Options, which as mentioned before, give you the right to sell a stock at a predetermined price. So in the example above if the price of ABC shares fell to $45 and we had bought Put Options giving us the right to sell ABC at $50, the Put Options would be worth money because you could buy ABC shares in the market for a cheaper price than you could sell them for. Wonderful isn't it, you can make money if the stock market is rising or falling!

To summarize a stock option has four components to it:
1. The underlying stock
The stock that the option is traded on (ABC Company in the example above).
2. The exercise date
The predetermined date, before which, you can use or exercise your option. Options always expire on the third Friday of each month (November 16th in the example above).
3. The strike price
The predetermined price you can buy the stock for ($50 in the example above). 4. The type of option
Either a Call or a Put option.

Here is the first key to successful stock options investing. It is very simple: practice, practice, practice. I cannot stress enough how important practice will be to your success as a stock options trader. Trading options is an inherently risky endeavor, however by learning the keys to successful stock options trading it is possible to mitigate this risk and maximize your gains. Options are a zero sum game, which means for every winner there has to be a loser. I'm sure you want to be a winner and not a loser, right? So you must take the time to learn the fundamental theories of options trading and practice the strategies behind options trading before you risk any of your hard earned capital in the market. It is only when you are winning seven out of ten trades on paper and you are confident in your trading plan and money management techniques that you should trade in the market for real. By the time you have finished reading these articles you will have a plan and know just what those money management techniques are. Look out for Key #2 coming soon.

US Government required disclaimer: Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of the Characteristics and Risks of Standardized Options. Copies of this document may be obtained from your broker, from any exchange on which options are traded or by contacting The Options Clearing Corporation, One North Wacker Dr., Suite 500 Chicago, IL 60606 (1-800-678-4667).