Options or Stocks
Posted on June 27, 2010
Filed Under Personal Finance | Leave a Comment
Trading stocks can be a great way to grow your money. But there is a way to increase your returns from the stock market. But if you don’t have a plan they can take your account to 0.
This is called stock options. What are options? Options give you the right to buy/sell a given stock at a given price on or before a given date. Let’s say that whatever indicators you are using are telling you that stock XYZ is probably going to go up.
If the stock is trading at $87 you can always buy it at $87 and make money as it goes up. Another option would be to buy the $85 call option for $8. With the call option you buy the right to buy the stock at $85 before the option expires in 2 months.
If the stock goes up to say $100 that means you have made at least $15 because your option would be worth at least $15 ($!00-$85). Now remember the option was originally bought for $8. What this means is that we had a total profit of at least $7 or 87.5%. Now compare that with the stock which would have given you a return of 17.6%, still good, but there is a big difference here.
Options are very powerful tools, but they can also work against you. In the above example if you held the stock all the way until expiration and the stock just pulled back to say $84, your option would have expired worthless losing you 100% of the total investment. Compare that with the stock, which was only down 3.4%.
There really are some dangers in option trading. This is why one of the best stock market trading tips you can get is to wait until you actually are making money trading stocks before even considering options. Stock options can make you a lot of money, but in the end all they do is magnify what you are doing already.
If you do have some experience trading stocks your next question may be how to buy options? You can basically buy an option at any online brokerage. But most brokers will require you to be approved to trade these options.
In most cases this means that you will have to have some experience trading stocks first. Really this is the best way to go. You don’t want to jump into this strategy unless you are already used to managing risk and picking trades. Basically stock options are just more leveraged investments for experienced investors. If done right they can be worth it.
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