There's plenty of money to be made in the stock market. But if you want to make money quickly, there's no better way than trading options.
The good news is if you've already been buying and selling stocks, you're well on your way to understanding how options trading works.
There are just a few key concepts to learn. Once you've got those down, you can start making trades and earning money with options faster than you ever could with traditional stock investing.
So let's get right into it.
Here's how options trading works...
How Option Contracts Work
An option contract gives the buyer the right to buy or sell shares of a stock at a certain price - called the strike price.
If you buy a call option, you get the right to buy the underlying stock at the strike price.
If you buy a put option, you get the right to sell the underlying stock at the strike price.
So let's say you think Apple Inc. (NASDAQ: AAPL) is going to rise in share price over the next month. (This is just hypothetical. We're not making a prediction here.)
You could just buy as many shares of the stock as you can reasonably afford. And if the stock goes up 10%, you'll get a 10% gain - minus any commission fees you pay.
But there's a lot more money-making potential in using an options trading strategy.
At the time of this writing, Apple trades at about $260 per share. So you could buy seven shares for about $1,820. A 10% rise would give you a gain of $192.
But a call option that expires in a month with a strike price of $260 only costs $5.25.
That means you could buy options contracts on 300 shares of AAPL for just $1,575.
If the trade goes your way, and AAPL rises 10%, you now have the right to buy $85,800 worth of stock for only $78,000.
Your $1,575 investment just turned into $7,800: a 395% gain.
That's the money-making potential of options trading.
Before you make your first trade, though, let's take a look at the factors that affect option prices so you understand how to minimize your up-front expenses and maximize your gains.
Option Pricing: Key Concepts and Terms
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That $260 strike price for an option on AAPL is at the money, because it's near the current share price of the stock. Strike prices for options can also be in the money, meaning the price is favorable to the option holder. Strike prices can also be out of the money, or unfavorable to the holder.
So if AAPL is trading at $260 and you bought a call option with a $255 strike price, that option would be in the money. You've already got a $5 per share profit baked in.
A call option with a $265 option would be out of the money, because you need the share price to rise in order to be favorable to you.
The price of an option is called the premium, and it's based on market fluctuations just like stock prices are.
Generally speaking, the more in the money an option is, the more expensive it's going to be. That is to say, the more likely the market thinks an option is to work out in your favor, the more you'll have to pay for it.
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Of course, the price per share will still be dramatically less than buying the stock outright. Which is why options are typically sold in bundles of 100. So in our hypothetical scenario where you bought options on 300 shares of AAPL, that would be three option contracts in total.
Also keep in mind that you don't need to exercise an option to profit from it. In our scenario, you would have been able to buy $85,800 worth of stock for only $78,000. That's a good deal, but the process might be too cumbersome to deal with on a regular basis.
No problem. You can sell your option on the open market at any time. When the share price of the underlying stock moves in your favor, the premium on the option will go up as well. So you can book your profits without ever having to buy or sell any shares of stock.
When you buy a call option, you are opening your position. So you buy to open. When you sell that option on the open market, you're closing your position. So you sell to close.
If you were on the other end of the trade, you could sell a call option to open your position. Then you're on the hook to sell the shares at the strike price. To close that position, you could buy an identical call option (buy to close) to offset your exposure.
Now that we've got the basics out of the way, it's time for the fun part...
Making Money with Options
There are lots of ways to make money with options, and we share a number of strategies here on Money Morning.
You can follow along with Money Morning's options trading specialist, Tom Gentile, who can give you tips on some of the biggest money-making opportunities on the market today.
And if you're ready to start generating some serious cash, just keep reading...
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