Let Me Explain Option Trading in
Really Simple Terms

Module 1: Option Basics
Lesson 1: Explain Option Trading

I could explain option trading all day, but unless you understand it, the profits from trading stock options will always elude you.

My goal for this lesson is for you
to walk away with at least a basic understanding of online options trading and why there's so much hype surrounding it.

This is the first lesson in the home study course and it was specifically designed with a few people in mind:

• Those who've searched the Web and still haven't found an easy way to explain option trading
• Those who are looking for an easy way to learn options trading
• And those who are frustrated with the technical and over-complicated online options trading tutorials

If anyone understands your frustrations it's me. I never found anyone to explain option trading in simple terms. I met a bunch of people who tried to explain option trading, but their explanations were way over my head.

I eventually pieced together my own analogy and that's what I'm sharing with you today. The following example will explain option trading and show you how profitable it can be.

Each month through our Trading Insight Newsletter, subscribers are given free trades, hot stocks, and general guidance to help them learn how to trade stock options.

Don't forget to take advantage of your free membership to the Trading Insight Newsletter. The "Trading Insight" newsletter will give you a deeper understanding of options trading and will allow you an opportunity to participate in our Options Coaching Program. You'll also receive 3 special reports titled the Truth Revealed Series. The Truth Revealed Series will help you navigate your way around the web and reduce your chances of being scammed by someone selling trading products.

Explain Option Trading

The Concept of Buying and Selling Contracts

For the purposes of this lesson I will only be referring to trading stock options, even though options can be traded on other securities such as commodities.

The first way I'd like to explain option trading is in terms of what I do on a day to day basis. I'm an option trader and trading stock options is what I do. A stock option is not a physical thing like owning shares in a company. Instead, it's a contract between two parties.

When you own stock (or shares), you actually own a piece of the company. But a stock option is an agreement, or contract, where one party agrees to deliver something to another party within a specific time period and for a specific price.

So trading stock options is essentially the business of buying and selling contracts (stock option contracts).

"Real estate investors" buy and sell homes. "Option traders" buy and sell contracts.

Contract: an agreement made between two or more parties.

It is no different than the contract you sign to buy a house or a contract you have with a lawyer or musician. Now let's move onto how you can actually make money buying and selling contracts.

Online Options Trading Analogy

Let's say you find an undeveloped piece of land that you believe will increase in value over the next few years. You don't want to buy it outright, but you would like to tie up the land with a contract that gives you the right to buy the land if you so choose to.

The land is in the middle of nowhere, surrounded by 20 miles of forest on each side. You have it appraised and find out it's worth $25,000. You approach the owner and ask him/her can they draw up a contract with a time period of 3 years that will allow you the right to buy the land any time during those 3 years for a set price of $25,000.

Remember this is what the land is worth right now. There's nothing around it and its just boring, raw, undeveloped land. You pay him $2,000 for the rights of this contract. You're not obligated to buy the land, you've just purchased the right to buy it. If you decide not to purchase the land your contract will expire, and you'll lose your $2,000.

You Hit the Jackpot!

Remember you have the right but not the obligation to purchase that lot next door for $25,000 AND you only paid $2,000 for the contract.

Now let's use a bit of common sense. Two years ago the land was only worth $25,000 because nothing was built around it. Do you think the land is worth more now that there are malls, housing developments, and Wal-mart next door?

Yeah, you bet your bottom that lot is worth more than $25,000. For exaggeration purposes lets say the lot is now worth $100,000. You're a happy camper! You own a contract that says you get to buy that land for only $25,000. So if you wanted the land you could exercise your contract and purchase the land for $25,000.

You would then be the proud owner of a $100,000 piece of real estate that only cost you $25,000. You could keep it, or sell it on the open market and pocket the difference between what you sold it for and what you paid for it ($73,000 or 270% return on investment).

Or you have another option. You could take the approach of an option trader. You could take that contract and sell it to someone else.

Remember you paid $2,000 for the contract. You now own a contract that says you have the right to buy a $100,000 piece of land for only $25,000. Do you think someone might be willing to pay you more than $2,000 to own that contract?

Yes any person in their right mind would.

A fact that needs to be taken into account is that if you were to buy the land (exercise the terms of the contract), you would need $25,000 and only then you could sell it for $100,000, thus realizing the profit.

On the other hand, if you were to sell the contract, you wouldn't need $25,000 to realize a profit. You can just simply turn around and sell the contract for a higher price. This fact alone is why I am an options trader.

Time to Make Some Money

So now you have an example of how buying and selling a contract can be profitable. It's also probably one of the easiest ways to explain option trading because as an option trader, buying and selling contracts is what you'll be doing.

**Tip** Do not dig deeper into the example. A lot of people try to figure out why a person would let someone tie up their land. Others want to know why the person who bought the contract didn't just buy the land. Keep your thinking on the surface level. Buying a contract and selling it at a higher price.

Here's the lesson: Trading stock options is where you invest a relatively small sum of money to buy a "contract" that controls something larger. Your research tells you that your contract will increase in value before a certain date. When it does increase in value, you're going to sell the contract for a higher price than you paid for it and pocket the difference.

At this point you may be saying to yourself, "I thought he was going to explain option trading. Instead he's talking about land and everything else but trading stock options."

You have to trust me! Understanding these examples will help everything else sink in later down the road. The concepts of trading stock options can be hard to understand at first so I'm taking baby steps to get you up to speed.

Trading Stock Options

You do research and feel that IBM stock will go up in price in a few months, but you don't want to put all your hard earned money at risk quite yet. Buying 100 shares will cost you $9,000 (100 shares * $90). You want to test the waters to see if your theory will pan out. In order to do this you buy a contract that gives you the right to buy 100 shares of IBM stock at $90. This contract costs you $680.

Compared to $9,000, $680 isn't a lot of money to risk.

You paid $680 for the right to buy IBM at $90. Six months later, IBM is trading at $130 dollars. So essentially you could exercise your contract, buy IBM for $90 and then immediately sell it for $130.

Of course, like in the land example, you could sell your contract to someone else for lets say $1080. In doing so, you would make a profit of $400 or 59% return on your money.

Don't worry if you don't fully understand this example. It doesn't stop here. I'll continue to explain option trading as the tutorial progresses along. As a matter of fact, this entire site and web based home study course was designed to explain options trading in great detail.

There is no way I can fit everything onto this one page.

Read the Module Instructions below and when you're ready, proceed to Lesson 2: What are Stock Options.

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If anything in the examples is unclear, then send me an e-mail through the contact page and I will improve the examples to make them more clear.