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Stock derivatives, or stock options as they are commonly called, are one of the most powerful and versatile financial instruments available today yet, as a result of there profit power and flexibility, they are often misunderstood by beginning traders and investors. Yet, if a few basic critical success factors are fully understood then stock derivatives offer individuals a chance to effectively take advantage of there enormous potential. These factors include understanding kinds of stock options available, leverage, controlling risk, understanding the time relationship on stock options, and what strike prices are and how to use them. There are two types of options that are offered on publicly traded shares - "calls" and "puts". When you believe that the stock of a company is going to rally and rise in price then you want to invest in call options as they appreciate in value on an upward move. If you believe that a stock is going to fall and depreciate in price then you want to invest in put options as they appreciate in value. Calls, then, have a upward directional bias and put options have a downward directional bias. The second factor to understanding stock options is that they offer one of highest sources of leverage by allowing you to control blocks of 100 shares per each option. For example, if you bought 100 shares of a $60 stock then you would have $6,000 invested but you would only need a few hundred dollars to control the same position with options. If your $6,000 worth of stock rose from a share price of $60 to $72 and you sold then you would realize a gain of 20% or $1,200. But if you owned call options on the same position you could conceivable earn a 200% or 300% gain! You should now begin to feel your eyes opening to the raw potential that options offer the investor with this kind of leverage but you really start to see there potential when you understand how options control your risk in even the worse circumstances. If you had invested in 100 shares of ABC company's stock at $70 a share then you would have $7,000 tied up in that position. Now, let's just project that the CEO of ABC announces that the company is filing for bankruptcy and as result the company's stock falls to zero. You have just lost your entire investment of $7,000! However, if you had used call options your cash outlay would have just been a few hundred dollars to control the profit potential of the same 100 shares. Whereas you lost everything by buying the ABC's stock you would only have lost a few hundred dollars with just owning the call option. By understanding just how important it is for you to limit your risk to the market or any stock you can begin to realize how stock options offer you that advantage. Stock options offer you an enormous advantage in profiting from the markets you must understand the concept of time in how it applies to option trading. Though they vary a bit, stocks offer different types of options with different time periods on them. These time periods, or what is commonly referred to as expiration periods, range from 30 days out to as long as 3 years with expiration days occurring every third Friday of calendar month. In my opinion, it is vital for you to understand the average holding days for your option trades so that you purchase the proper option so that it has enough time on it so you have time to profit from you position. If the average holding period is seven days and it is the middle of the month then purchase the next month's options so that you have 2 weeks plus another month in order to give your option position enough time to profit. Any option under 30 days till expiration is rapidly disintegrating in value due to time decay. The other success factor you must come to understand when trading options is understanding strike prices. Strikes are terms assigned on the price of an underlying stock of a publicly traded company. If, for example, ABC company's share price is at $50 its strike prices on it's available options might be a $45, $50, and $55 which you can observe in the price tables of any financial newspaper. Now, each strike price has certain pros and cons depending in large part your particular option strategy but, for now, knowing what strike prices are and understanding how to implement them in your trading decision process will you help you make the most effective selection choice. By learning to implement stock options into your investment choices you can add their enormous potential for high profits and risk control to your trading arsenal. By taking some time to reread this article as well as similar material you can begin to see how they can help you profit in almost any market. Whether the market is rising, falling, is range bound, or you are just trying to protect your stock portfolio from market volatility by taking advantage of the power and risk control of stock options you can take advantage of almost every opportunity in the market.
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