So, you want to make money trading options. Then you need to develop the knowledge base and skill sets of an options trader. If you are already a stock trader you should realize that there a difference between stock and options trading. However, each type of trading requires fundamental and technical analysis of stocks and stock prices. And each typically requires a trade station and trading software. From the same starting point a stock trader analyzes and then buys, holds and sells stocks. An options trader enters into a contract to buy or sell stocks if certain conditions should arise.
Buying and Selling Options Contracts
The difference between buying and selling options contracts is crucial for options traders.
Buyers of stock options pay a premium for the right to buy or sell a stock within the period of the contract. The contract price is called the strike price and is set for the duration. Thus an options trader looks for a stock that he thinks will go up in price and buys a call contract. This gives him the right to buy if he wishes but confers no obligation to do so. If he believes that a stock will go down in price he will purchase a put contract. This gives him the right to sell the stock if he chooses. In each case the trader may simply exit the contract by making the opposite trade and pocket his profits or absorb his losses. With both puts and calls an options trader limits his risk to the amount paid for the premium. Because he does not need to pay the full price of the stock he can often enter a trade for little money and earn a multiple of his investment.
Selling options is typically more profitable than buying over the long run. However, the risk of an occasional big loss often limits the selling or writing of options to trading houses and traders with deep pockets. In selling calls or puts the options trader sets a price based on his expectation of whether a stock price will go up or down and just how much. He sets this price in such a way that he is typically guaranteed a profit. He collects a premium for absorbing the risk that the stock in question will not perform as expected. When an options trader sells a call contract he agrees to sell a stock at the strike price no matter how high that stock might go. He agrees to buy a stock at the strike price not matter how far that stock might fall. Selling a covered call option only entails the risk of losing out on a run up in stock price because you already own the stock. Selling an uncovered call option opens the options trader to significant risk if the stock price goes up a lot. This is because he will need to purchase the stock at the higher price and sell at the lower and absorb the consequent loss.