One of the things that most successful traders get asked is how we trade options to make a profit. Options are a great tool. They are flexible and they make it easy for you to diversify. You can generate good income with options if you make the right decisions.
Options can help to protect your investments should the market decline, and they can offer a way to increase your existing income. They can also help you to acquire equity at lower prices and benefit from the change in value of an equity, even if you do not outright own that equity or want to sell it all.
Buying Options
There are a few ways that you can buy options. You can hold the option until maturity and then, trade it when the option matures. Alternatively, you can purchase an option and then trade it before the date at which it expires or you can let the option expire. If you choose to let the option expire, you would have no profit but your loss is limited to the premium that you paid to purchase the option and any commissions.
While that third option may not seem so appealing, it means that your loss was limited, no matter how much the stock price fell, you would lose only what you paid for the privilege of having the option. In the other instances, you took a profit.
When you buy options, you are under no obligation to do anything. When you sell options, you are obliged to sell if a buyer comes along and wants to exercise their option. Selling an option is also known as writing a call. You, the seller, sell a right to purchase a stock from you to a buyer. You specify the price and a time limit for the option. No matter how much the market price of the stock changes, you have set that option.
The most popular way to sell a call is to use a covered call. This means that you are selling an option to purchase an equity that you currently own. If the buyer decides that they want to use that option, then you are obligated to sell it to them. It does not matter whether the current price is higher or lower than the price written on the call.
It is possible to write an uncovered call and sell the right to purchase an equity which you do not currently own. Uncovered calls carry a huge amount of risk with them and are not something that should be entered into lightly.
Now that you know how we trade options, you can give it a go yourself. Options are a great financial instrument and you can use them incredibly effectively – but make sure that you trade only money that you can afford to lose. Keep a diverse portfolio to protect yourself from crashes in any particular market and seek independent financial advice before making any big decisions.