A stock option can make a much larger profit in a shorter amount of time than actually owning a stock. But there is one catch, they expire. While a share of stock will not, it can decrease and increase in value. With a stock option there is a certain strike price that must be met, or move towards to turn a profit. When purchasing a stock option it is important that the stock moves in a direction fairly quickly.
If a stock just stays around the same amount as when it was purchased it can be at risk of decreasing in value, or even worse, becoming worthless. “Options are not available on every stock. There are approximately 2,200 stocks with tradable options. Each stock option represents 100 shares of a company’s stock” (As stated in Yahoo!’s finance education).
Calls and Puts
There are many different types of strategies to choose from when playing with stock options. These strategies include buying and selling calls and puts. Each of these are purchased at a certain strike price (usually a hundred shares at a time). When buying a call, a stock must increase in value to make a profit.
With a put, a stock must fall to make money. The more dramatic the move means a higher amount of money it can be sold back for. Stock options can do more than just be sold, they can be exercised. Many traders buy stock options to protect their current investments. If a stock falls, and they possess puts, then they can actually sell their stocks back at the strike price on the put. This can save incredible amounts of money.
Making Money in a Falling Market
The beauty of a stock option is that profits do not just come from a stock increasing in value. When the stock market is in terrible condition there is still plenty of money to be made. For example, when banks were failing in the fall and winter of 2008 many people lost their fortunes, but also many people gained them. This was through the purchase of puts. By investing a small sum in puts for certain banks, one could turn their investment into more than six figures.
The banks did not fall in just one day but over several months. By watching these trends, it can help make great financial decisions. But sometimes it can be confusing to decided if a stock is going to skyrocket or plummet. If this occurs, spreads can be bought. A spread is where calls and puts are purchased and if the stock moves hard in one direction a large amount of money.