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Stock Options Can Lower Risk & Increase Return

Stock Options are misunderstood and thus dangerous for most, but can be powerful tools (if used properly) to lower risk and increase return on your equity investments.  This is the beginning of a new series….

We want to share one powerful set of techniques for buying stocks or ETF’s with you.  These are slightly more complicated than simply buying a stock directly, but can be far more profitable.  Have you ever wondered how Wall Street seems to make so much money no matter what is happening in the markets?  We’re about to share a couple of the strategies that help them guarantee themselves income while reducing their risk.  And you can use these exact strategies.

Stock Options are usually either scary, exciting, or a complete mystery to most investors.  Stock Options are tools that allow you to make or lose a lot of money in a short amount of time.  The majority of investors who trade stock options lose all of their money on them.  However, Wall Street makes incredible profits with options primarily because they use them in exactly the opposite way that most investors use them.  We’ll get into these strategies after you first get a basic understanding of options.

Stock Options Explained

As stated above, stock options are thought of as inherently risky simply because most small investors who get involved with them lose money.  However, this fact is more based upon the way they use options than the type of security itself.  We’ll explain how the different types work and then you’ll clearly see the ways to speculate with them which are very risky (and subsequently offer the possibility of higher rewards).  You’ll also see ways which you can use options whereby you will get paid by another investor to do exactly what you were already planning to do!

Types of Stock Options

There are two types of options that can be bought and sold on the stock market.

1)      A Call Option gives the owner the right (but not the obligation) to buy a stock at a certain price on a certain date in the future.

2)      A Put Option gives the owner the right (but not the obligation) to sell a stock at a certain price on a certain date in the future.

Call Option Buyers – If you buy a Call Option, then you pay money up front to the seller of the option in exchange for the right to buy the stock on a certain date agreed upon in the future at a certain price.  Of course, you would only want to buy the stock at that price on that date if the market price of the stock on that date is higher than your agreed upon strike price.  If the stock is not trading higher than your strike price on that date, then your option will expire worthless.

Put Option Buyers – If you buy a Put Option, then you pay money up front to the seller of the option in exchange for the right to sell the stock on a certain date agreed upon in the future at a certain price.  Of course, you would only want to sell the stock at that price on that date if the market price of the stock on that date is lower than your agreed upon strike price.  If the stock is not trading lower than your strike price on that date, then your option will expire worthless.

Call Option Sellers – If you sell a Call Option, then you are PAID money up front from the buyer of the option in exchange for your promise to sell the stock on a certain date agreed upon in the future at a certain price.  You will have the obligation to sell this stock when that date arrives if the stock in question is trading above the strike price.  The buyer paid you money for your promise to sell, so you of course, must follow through if that scenario occurs.  If the stock is trading below the strike price on the expiration date then you keep the premium you were paid and the obligation is over.

Put Option Sellers – If you sell a Put Option, then you are PAID money up front from the buyer of the option in exchange for your promise to buy the stock on a certain date agreed upon in the future at a certain price.  You will have the obligation to buy this stock when that date arrives if the stock in question is trading below the strike price.  The buyer paid you money for your promise to buy, so you of course, must follow through if that scenario occurs.  (He bought the Put Option and thus has the “right” to sell the stock to you.)  If the stock is trading above the strike price on the expiration date then you keep the premium you were paid and the obligation is over.

This is the beginning of a new series which we’ll be revisiting every few days.  You can check out the series we just finished on professional money management and funds by following these links: Pt 1, Pt 2., Pt 3, Pt 4, Pt 5, & Pt 6.

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