I'll Explain Stock Options Trading
Using a Real Trade!
Module 1: Option Basics
Lesson 4: Stock Options Trading
Now that you have a general understanding of options trading, it's time to explain stock options trading.
A quick recap from the previous lessons:
Stock option contracts grant you the right, but not the obligation, to buy or sell shares of a stock at a set price on or before a give date (time period).
Stock options trading is the buying and selling of those contracts.
As a stock option trader you're going to 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.
1 stock option contract = 100 shares of a company's stock. So when you buy 1 contract you are buying the right to buy or sell 100 shares of that stock.
A Put option gives its buyer the right, but not the obligation, to sell shares of a stock at a specified price on or before a given date.
A Call option gives its buyer the right, but not the obligation, to buy shares of a stock at a specified price on or before a given date.
Stock Options Trading Example
You do some research into the healthcare industry. You find a good company and based on your research you feel the stock price will increase over the next few months. The companies name is Humana, Inc. and the ticker symbol is (HUM).
You look up the stock price and "HUM" is currently trading for $42 a share. You buy 10 option contracts that give you the right to buy 1000 shares of "HUM" at a set price of $45 anytime between now and March (time period).
- The underlying security: HUM
- The expiration month: March
- The strike price: $45
- The type of option: Call, the right to buy stock
The contracts cost you $1,665. That is what they were worth the day you bought them when the stock was trading at $42 a share. This $1,665 is a small price to pay compared to the $42,000 you would have paid if you bought the stock outright ($42 * 1000 shares).
Eight days pass by and the stock price of Humana, Inc. increases in value as you expected. The stock is now trading for $46 a share. Now that "HUM" is trading for $46 do you think your contracts are worth more than $1,665? Yes they would be!
Think of it this way. "HUM" has increased in value by $4 since you bought your contracts. When "HUM" was trading for $42 these contracts were worth $1,665. Now "HUM" is trading for $46 a share.
Time to Make Some Money!
Your contract is now worth more money and you essentially turn around and sell it to someone else for lets say $2,534. In doing so, you would make a quick $869 or 52% return on your money. Not bad for 8 days of work.
That's stock options trading at its best!
Again, please don't worry about who you're selling your contract to or why they would buy it. All you know is that you have a contract that is worth more than what you paid for it and you're going to sell it and pocket the difference...
Still unclear? Let me explain stock options trading this way...
Remember in Lesson 1 how the land contract went up in value as the underlying asset it was tied to (raw land) went up in value? Now we have a stock option contract and its value also goes up when the underlying asset it's tied to (stock) goes up in value.
Do You Want to See a Real Trade?
Now that I've explained stock options trading (the buying and selling of contracts) you may be saying to yourself, "yeah right, it sounds good in theory, but those numbers in the "HUM" example are not realistic". Fair enough!
In one of the previous lessons I told you I would explain option trading and also show you how profitable it can be. What better way to show you then a real life example. That Humana, Inc. example above was a real trade I made. Here's proof:
I made $869 and a 52% return on my money in 8 days. That's the power of stock options trading!
If I were looking to earn a better return on my money than my mutual funds, then I'd be done right here. I wouldn't have to make another trade for the rest of the year. Heck, I could take two years off and still beat my mutual fund. I'm joking but I think you get my point.
How in the world did you do that? Where can I sign up for trading lessons?
Ok, hold your horses let's continue to go over the basics. You'll get there eventually. Returns like these don't happen often, but they do happen nonetheless.
Proceed to Lesson 5: Puts and Calls.
Module Instructions: According to how the site is set up, you are now in Module 1: Lesson 4 (Stock Options Trading). For the most effective learning experience, read through each lesson in this module one by one, in the exact same order as they are listed in the table of contents to the left.
Return to the top of this page "Explain Stock Options Trading"
Return to options trading "Home Page"
If anything in the example is unclear, then send me an e-mail through the contact page and I will improve the examples to make them more clear.
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