Option trading for idiots
If the buyer is wrong, he lets the option expire, forfeiting only the stock option premium -- not the loss of value for those shares. When the value of a stock rises above the strike price of a call option before it expires, the buyer could exercise the option and purchase the shares. However, now the option has a value of its own, and this is typically how options trading makes money. The buyer may now sell his contract to someone who wants to purchase that stock cheaper than the current market rate, which the option writer is obligated to provide.
The value of that sale depends on the difference between strike price and current value, and the time remaining on the option.
As long as the buyer recoups the option premium, a profit is realized. The buyer of a put option wants the value of a stock to fall below the strike price. In this case, the writer is obligated to buy shares at the buyer's option for a price which is now higher than the market.
That option contract becomes attractive to holders of the falling stock. The buyer earns a profit by selling the put option for an amount exceeding the option premium. Options Trading for Dummies. Share Share on Facebook. Close-up hand on stock chart. Please enter a valid email. For investors not familiar with options lingo read our beginners options terms and intermediate options terms posts. Using stock you already own or buy new shares , you sell someone else a call option that grants the buyer the right to buy your stock at a specified price.
That limits profit potential. You collect a cash premium that is yours to keep, no matter what else happens. That cash reduces your cost. Thus, if the stock declines in price, you may incur a loss, but you are better off than if you simply owned the shares. Cash-secured naked put writing. Sell a put option on a stock you want to own, choosing a strike price that represents the price you are willing to pay for stock.
You collect a cash premium in return for accepting an obligation to buy stock by paying the strike price. A collar is a covered call position, with the addition of a put. The put acts as an insurance policy and limit losses to a minimal but adjustable amount. The purchase of one call option, and the sale of another. Or the purchase of one put option, and the sale of another.