This is the first in a series of posts on options. This series will help you to understand options contracts, their strengths and weaknesses, and risks. Most importantly, this series will make you a more successful investor.
How Do You Make Money in the Stock Market?
According to Gallup, a majority of Americans have money in the Stock Market, largely driven by employer based retirement plans. Investing in this way is highly dependent on the continued growth of the American economy. While it is possible to make money in a down market, the majority of mutual funds and ETFs will not.
Did you know there is a way to make money in the Stock Market whether or not it’s rising, sinking, or even going sideways?
Now that’s OPTIONS!
Wait, don’t click away now! Yes, I know you’ve heard options are risky. But did you know they are based on contracts meant to decrease risk? And you can still use them in that way today? Anyone who knows me would know I do not like risk (unless it’s published by Hasbro). In the coming posts we are going to learn how to use options to boost your investing profitability in four specific ways:
1) Earn an extra income stream on owned shares
2) Earn extra income on idle cash
3) Get paid to wait for the price that you want
4) Protect yourself from decreasing share value.
Sound promising? Lets do it! First things first…
What are options?
At the most basic, an “option” is just a contract between two people. The contract states that they have agreed to exchange a product at a specific price by a specific date.
There are two kinds of stock option contracts:
1. Calls
2. Puts
There are two people in the stock option contract:
1. The Buyer
2. The seller
How does it work?
Call Options:
1. The buyer of a call option has the right to buy shares of the stock (or underlying) at a specific price.
*The buyer may choose whether to exercise the contract or not.
2. The seller of the call option has an obligation to sell shares of the underlying if the buyer calls them (chooses to buy).
* The seller receives payment, called a premium, at the time the contract is opened.
Put Options:
1. The buyer of a put option has the right to sell shares of the underlying at a specific price.
* The buyer may choose whether to exercise the contract or not.
2. The seller of a put option has the obligation to buy shares of the underlying at that price if the buyer puts them (chooses to sell)
* The seller receives a premium at the time the contract is opened.
This is quite simple once you get the concept. The more confusing option type is the Put. The buyer of a put is “buying the right to sell” – it is a bit of a brain twister at first. In layman’s terms, if you’ve bought a put contract, that means you’ll be able to sell your shares at a specified price if it benefits you.
Click Here to see an example of an options contract.
There are more terms to know when playing with options. We will go over them next time.
If you have any questions or comments about this material, please place it in the comment box below! I would love for these posts to be an interactive classroom for everyone.
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Pictures used with permission:
Micheile Henderson
