Did you know that you can make money when the markets go down? As a matter of fact, investors make millions of dollars each year when the stocks markets fall or a specific stock price declines. It’s true! Buying Options gives you the opportunity to make money when the markets go up as well as down.
Options are a great way to hedge against a potential correction in the markets. They are also a great way to leverage your money and earn 10, 20, or even 30 times more than if you were to buy the same exact stock the option contract can buy. This may seem confusing to you, but the fact of the matter is that you can make an absolute fortune in any type of market if you know how to trade Options. But like most investments, with higher rewards come higher risks and options aren’t suitable for all types of risk profiles. So before going any further it’s important you really understand what Options are and the level of risk involved.
What Is An Option?
An option is a contract that provides you with the right to execute a stock transaction, that is to buy or sell 100 shares of stock. Options always refer to a 100-share unit which means that when you buy 1 contract, you are buying 100 shares. When you purchase an option contract, you are buying a specific stock and a specific fixed price per share that remains fixed until a specific date in the future. When you buy an option, you are NOT buying equity in the stock. You are buying the contractual right to buy or sell 100 shares of the stock at a fixed price.
But why would anybody buy an option contract? Can’t they just buy the shares directly? There are two extremely beneficial answers to this question.
- Investors buy options to leverage their portfolio – Let’s say that you wanted to buy shares in Microsoft because you thought the stock price was going to take off in the near future. The price per share at the time was $25.00 which meant that if you wanted to buy 1,000 shares you would have to tie up $25,000. For the sake of this illustration let’s imagine that you didn’t have $25,000 to invest with but you really wanted to make a big move with Microsoft. This is where options come in. You decide to buy a call option rather than pass up this trade altogether. We’ll assume that you had to pay $2.00 per option which required you to invest $2,000 to control $25,000 worth. The downside? If the stock price goes the other way, or doesn’t hit your strike price in time (let’s say $30.00 per share),you lose all your money. The upside? As predicted, Microsoft soars to $30.00 per share and you sell at a $5,000 profit or 150% profit! Now, if you’d bought the shares instead of using the call options, you would have profited as well, but you only would have made 20% and tied up $25,000 instead of $2,000. This is why investors love trading options! It gives them the ability to use leverage to their advantage.
- The option price is fixed regardless of what happens to the underlying stock price – The share price of the stock will rise and fall on a daily basis and the value of your investment will be effected by this accordingly. With options however, the stock price you can apply to buy or sell 100 shares is frozen for as long as the option remains in effect. So no matter how much the price of the stock moves, your price is fixed should you decide to purchase or sell 100 shares of the stock in the future. An option’s value is going to be determined by a comparison between the fixed options contract price and the stock’s current market price.
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