Stock Option Investing: Educate Yourself Before Getting In

Stock option investing is less familiar to many inexperienced investors than other types of investing. However, there are those who advocate stock options as a better way of investing than a buy and hold strategy with actual stocks.

Define Stock Option Investing

Stock option investing means to buy a stock without actually trading the actual stock. Instead, you purchase an option for the underlying stock.

These options can be used to engage in trading the stock without actually being involved in the buying and selling of the stock itself.

These options can be purchased for nearly every individual stock in the U.S., Europe and Asia. They are usually sold as one stock option for every 100 shares of the stock underlying the option.

How Stock Option Investing Works

An investor dealing in stock options will decide which stock options to purchase using the same strategies he or she uses to determine an actual stock to purchase. The underlying philosophy for making a stock option choice should be based on the foundational company business philosophy, the management, or the long-term history of the stock.

  1. After choosing a stock, you buy an “in the money” call option for every 100 shares of stock you are interested in.
  2. You then wait for the price of the stock (and therefore the price of the option) to increase.
  3. Ideally, you will then sell the option, and you will realize a profit.
Some Advantages to Stock Options

While the idea of stock options is a bit unsettling to those who are unfamiliar with them, there are at least two substantial benefits to investing in stock options.

The first is that the cost of stock options is much lower than the cost of actual stock. Because of this, you as an investor need a smaller amount of money in order to invest in the stock. For example, the cost of Google (GOOG) is beyond the reach of many investors, but with options trading, a smaller investor can take advantage of the growth of such companies.

You can have more active trades going on at the same time, and can invest in many stocks that might otherwise be out of reach.

The second advantage is that the amount of risk you incur in options trading is limited to the amount that you paid for the option, regardless of how far the price of the stock itself drops.

For example, if the price of a stock plummets by $100 a share, a person holding 100 shares of the actual stock is out $10,000 – and they generally feel they have to hold onto the stock regardless so as to mitigate any further loss. Nonetheless, the stock could fall further, and they would be out even more money.

The options trader, however, is likely out only about $3,000, and is at no further risk, regardless of how far the stock drops. Using stock option investing helps you have a better handle on your financial exposure.

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