Options Trading for Beginners: Making More of Your Money

Options trading is an investment vehicle for experienced investors, who track their investments proactively. It is not a suitable vehicle for investors looking to maintain assets without direct management, as it's very much a timing related purchase and float. Options trading is an excellent technique for using financial leverage to make bigger purchases.

A very simple example of an options trade would be this: If you're selling a commodity worth $100,000 (say 1,000 shares of a stock worth $100 per share), and a prospective buyer likes the price, they can offer to pay for an option to buy all of those commodities, while spending the time researching other investments. Say, for example, they're offering you $1,000 to hold that price for them while they gather the rest of the funds, which they say will take three months.

When three months passes, they either pay the remaining $99,000 for the shares of the stock, or forfeit the option. If the stock goes up in price to $110 per share from $100, they can either buy the stock, or sell the option to someone else for the difference between the old price and the new price. Either way, the person holding the option stands to make a tidy profit.

Options trading has its own set of terminology, which we'll get into a bit later, but the basic premise is this: You buy an option to purchase a stock or commodity at a given price; the option expires after a given time period (American style options trading), or the option must be exercised on a specific date (European style options trading).

There are two principle types of options that are traded. Calls increase in value as the stock price rises, and puts increase in value as the stock price declines. (There's a lot of fiscal mathematics behind both of these, but the layman's explanation will suffice.) In most cases, options are sold to other investors just before they expire; most options traders don't end up holding shares in the stock they have options for; the options are bought, sold, liquidated and transacted before their expiration dates. It is possible to have both call and put options on the same commodity or stock; this is a "straddle" strategy.

Options trading is not a casual investment strategy; it's a strategy used by people who are investing as their profession, or who intend to manage their own wealth directly. The benefits of options trading is flexibility, coupled with (in the case of put options) a bit of a countercyclical strategy for bear markets.

The key to options trading is market research on specific stocks; an options trader will be researching stocks that are either slated for a price spike (call options) or are likely to undergo a price decline (put options). How quickly these options express themselves is a measure of market volatility, and most options traders will try to take a neutral position – they'll put in put and call options to cover both directions, and to cover themselves against broad market trends.

Options arbitrage is a lower risk strategy done by floor traders, and can be short term profitable, with good liquidity. The aim is to swap options with other traders before certain factors influence the market, or to get rid of underperforming options while still getting some profit out of them. Options arbitrage is perhaps the best place to start in options trading for a novice.