What is Options Trading? - Strategies & Examples

Instructor: Yuanxin (Amy) Yang Alcocer

Amy has a master's degree in secondary education and has taught math at a public charter high school.

You'll learn about options trading in this lesson and how stock buyers can use this way of trading to their benefit. Learn how it can provide a safety net so stock buyers can prevent losing too much money.

Options

This lesson is about options and how stock buyers can use options to their financial benefit. Put simply, an option is the right to buy or sell at a certain price within a certain time period. It's like when you go to a store to purchase a television on sale and the store gives you a rain check because they were sold out of the televisions. You can then use the rain check to purchase the television for the same sales price at a later time. Options are similar. With an option, you can purchase or sell your stock at the agreed upon price any time before your option expires. Unlike standard stocks, you purchase options 100 shares at a time.

The Call Strategy

In options trading, when you purchase a right to buy stock at a certain price, it is called a call. Some stock buyers use a strategy involving the call option, so they end up purchasing stock for a lower price than the current market price for the stock. For example, a stock buyer purchases a call option to buy XYZ stock for $14.50 that expires in 30 days. After 15 days, the stock buyer notices that the stock has increased in market value to $15.50. The stock buyer decides to exercise his right to purchase the stock for $14.50 on that day. After purchasing the stock, he has already made a profit of $1 per share. On 100 shares, he will have immediately made $100 minus any broker fees.

For this strategy to work, the call option is exercised or used when the option price is lower than the current market price of the stock.

The Put Strategy

The other strategy that stock options buyers can use involves the put option. A put is when you have the right to sell a stock at a particular price. The option is useful to stock buyers in helping them not to lose money when the stock market is decreasing. A stock buyer benefits from using the put option when the price of his put option is higher than the current market price of the stock. For example, say a certain stock buyer has purchased a put option for ABC stock that allows him to sell the stock for $50.00 in the next 30 days. He purchased the stock for $40.00 six months ago. The stock buyer purchased a put option just in case the stock starts losing value. The stock buyer notices that within the next 30 days, the ABC stock price keeps dropping. He is thinking, uh-oh. This is not good. He's going to lose all his money if he doesn't sell. But the stock is dropping fast and is now at $42.13. If it drops anymore, then he will not have earned any money at all. This stock buyer exercises his put option to sell the stock for $50.00. Now, instead of just making $2.13 profit per stock, he has now made $10 profit per stock. Because he has purchased the put option, it guarantees him that somebody will purchase the stock at that price from him.

The put option is useful when you want to protect yourself from falling stock prices. You get to sell at a higher price than the current market price.

Examples

Let's look at a couple of examples.

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