Introduction to Stock-Option Basics

In trading options, there are many avenues of opportunities in the financial arena and with the right knowledge, you can reduce the trade risk while increasing your probability of making a nice profit.

 In stock trading, your opportunity is limited to either Buy the stock or Sell the stock. Simply stated, you are limited to only two available types of transactions.

Introduction to Stock-Option Basics

 Now consider the options market. You have two separate equitable Option vehicles to work (i.e. Call and Put) in addition to the stock (i.e. Buy and Sell) which can be utilized in many combinations. The option instruments have a range of strike prices with different expiration months to combine and many specific strategies dependent upon the market conditions. The number of combinations is considered "limitless" and provides you with specific strategies that are "customized" based upon the different market conditions, timeframes and acceptable risk levels.

 Option is defined as a contract between a Buyer and Seller (i.e. not to be confused with the buy and sell of a stock) which provides the right (i.e. not the obligation) to buy or to sell a particular stock at a certain price on or before a specified date based upon a market premium (i.e. payment).

 A contract controls typically 100 shares of stock which is the minimum amount. As an example, if you want to control 500 shares of stock, you would need to purchase 5 contracts (i.e. 500 divided by 100). But when options are quoted, they quoted as a per-share basis.

 In an option transaction there are always two parties involved, i.e. a Buyer and a Seller. Therefore, the Buyer of an option has the right but not the obligation to exercise (i.e. execute) the option. In other words, its the Buyers choice and the Buyer is considered the Option Holder. On the other hand, the Seller (i.e. Options Writer) is in a legally binding contract and has the legal obligation to comply with the contract if the Buyer decides to execute the contract.

 Apparently, the Buyer and Seller have two different obligations as well as different risk levels. The Seller appears to have a higher risk profile, which is contrary to being in a position to control the trade at a lower risk and at a hedged risk trade. This does not mean that being only a Buyer of options is advantageous, but in many situations be in a position to be both the Buyer and Seller or even the Buyer of multiple options. The point is to best avoid being only the Seller, which will significantly increase the risk and give control to the other party. (Note. Reserve this type of trade to the professional option trader.)