Learn about the four basic option strategies for beginners. A standard option contract on a stock controls shares of the underlying.
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One option contract controls shares but typically costs only as much or less than a single share, depending on the strike price. Puts are also popular because they let the investor profit from price decreases.
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With typical investing — buying and selling securities — you have to buy low and sell high to profit. A covered call is a strategy that investors can use to produce extra income from their portfolio of stocks or ETFs. When you sell a call to someone, you receive income in the form of the premium that person paid to buy the call option.
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A covered call is a call sold for shares that you already own. For example, if you own shares of Twitter stock and sell a call for Twitter, the call is covered because you own the shares you would have to sell if the option holder chooses to exercise the contract. To sell a covered call, you typically sell the call option with a strike price above the current share price. Because you already own the shares, your losses are limited to losing the shares you own. A protective put is a strategy that investors can use to limit their potential losses from holding a security.
It functions similarly to an insurance policy. For example, you could buy shares of Starbucks stock. To execute a straddle, an investor buys two options, one call and one put. Both options should have the same strike price and expiration date. If the stock gains a lot of value, the trader can exercise the call option to buy shares below market price and sell them for a profit.
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If the stock loses a lot of value, they can exercise the put option, buying shares at market price, and selling them for an immediate profit to the option writer. Selling options tends to be much riskier than buying options. With the exception of selling covered calls, selling an option involves large, sometimes unlimited risk.
You can earn income from the options you sell, but one instance of bad luck could lead to you losing your portfolio. Buying options is less risky because the most you can lose is the premium paid. Still, options inherently involve a significant amount of leverage. This makes them far more volatile than normal securities like stocks and ETFs.
Trading options without fully understanding how they work or how volatile they can be is dangerous and could lead you to lose significant amounts of money.
Despite their popularity, options can be highly risky and should only be used by experienced traders who can handle their risk. Products like Motley Fool Options will give you the tools you need to learn how to properly invest in options. All Rights Reserved. Sign in. Forgot your password? Get help. Password recovery. Money Crashers. About Money Crashers. Recent Stories. Read more. Advertiser Disclosure X Advertiser Disclosure: The credit card and banking offers that appear on this site are from credit card companies and banks from which MoneyCrashers. Date February 11, TJ Porter.
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Investing Stocks. Follow MoneyCrashers. Trending Articles. Where Should I Live? Become a Money Crasher! Join our community. Share this Article. What Are Options? The party buying the option pays a premium to the party that writes the option. There are three elements to all options, regardless of their type: An underlying security A strike price An expiration date Each option contract describes a transaction that could occur in the future. A typical contract involves shares of whatever underlying security is involved.
Call Options Call options are one of the two main types of options. Put Options Put options are the other main type of option. Risks of Put Options For buyers of put options, the risk is that the market price of the underlying security will remain above the strike price. The other component of option value is time value.
Options Trading Strategies These are a few of the most basic option trading strategies. Buying Calls Buying calls is a basic bullish strategy. Buying Puts Buying puts is a basic bearish strategy. Selling Covered Calls A covered call is a strategy that investors can use to produce extra income from their portfolio of stocks or ETFs.
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Protective Puts A protective put is a strategy that investors can use to limit their potential losses from holding a security. When he's not writing about all things personal finance, he enjoys cooking, esports, soccer, hockey, and games of the video and board varieties. Make Money Explore. Manage Money Explore. Save Money Explore. For professionals, Interactive Brokers takes the crown as the best options platform. Additional savings are also realized through more frequent trading. Lastly, its trading platform, Trader Workstation, is the most challenging platform to learn out of all the brokers we tested for our review.
There's a healthy variety of reputable brokers to choose from in the world of options trading. It's a work of art. In its most basic form, a call option is used by investors who seek to place a bet that a stock will go up in price. Buying a call option contract gives the owner the right but not the obligation to purchase shares at a pre-specified price for a pre-determined length of time.
As the stock price goes up, so does the value of each option contract the investor owns. Conversely, if the stock price goes down, so does the value of the call option. Each contract represents shares of stock.
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In its most basic form, a put option is used by investors who seek to place a bet that a stock or other security such as an ETF, commodity, or index will go down in price. Buying a put option gives the owner the right but not the obligation to sell shares of stock at a pre-specified price strike price before a preset date expiration.
The further the stock falls below the strike price, the more valuable each contract becomes. Alternatively, an increase in the stock price will decrease the value of the put option. Each online broker requires a different minimum deposit to trade options. To apply for options trading approval, investors fill out a short questionnaire within their brokerage account.