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Stock options work by giving you the right to own shares of a stock at a fixed price by a specific date.
Options come in contracts of 100, which means each contract gives you an option to buy over 100 shares of a stock.
One of the benefits of options is that they can be purchased for a fraction of the price of the underlying stock. This allows you to profit from a stock without ever having to buy it – or sell shares short – and thus without risking a larger portion of your trading funds.
Fortunately, it doesn't have to be. We'll show you what you need to know to get started and realize just how easy it can be to trade options.
And we'll start with the key terms you'll need to know…
Understanding Stock Options Trading
To understand stock options trading, it's necessary to know some of the main terms.
The first terms to know are "calls" and "puts."
Call options give you the potential of realizing a profit if the underlying stock increases in price between your purchase of the option and the expiration date.
Put options give you the potential of realizing a profit if the underlying stock drops in price between your purchase of the option and the expiration date.
The next terms to know are what makes up the options contracts, starting with the strike price. This is the price you can buy or sell shares of the stock for.
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"In the money" means the stock is trading above the strike price, in the case of a call option, or below the strike price, in the case of a put option.
"Out of the money," on the other hand, means an option is trading below the strike price in the case of a call or above the strike price in the case of a put. In other words, it's not worth exercising the contract.
And a share price at about the same level as the strike price is "at the money."
Now that you know some basic terms, here's how to trade stock options.
Here's one options trading strategy to use.