Four Foundations of Stock Option Trading
In today's markets, it is almost impossible to find any investment that offers more flexibility, leverage, and limited risk than stock option trading. Especially at this time in history with online option trading which puts the power of these sophisticated investments at the disposal of both the aspiring trader as well as the veteran trader? Unfortunately, the strengths of these investments are also the biggest obstacles to mastery for most traders as some strategies become seemingly to complex to master by most would-be option traders. However, by understanding the four basic stock option trading strategies you can construct a foundation for trading mastery with stock options. The four basic strategies you must understand are the long call, the short call, the long put, and the short put.
Buying a call is the most basic of option strategies and usually constitutes an aspiring trader's first option trade after gaining some experience buying and selling stock. When you go long a call that means you are bullish on a stock and one call option controls 100 shares of stock. Your risk is limited to the premium that you paid since you cannot lose any more than that by using stock options. Your reward can be unlimited if the stock explodes in value. Time decay works against you in this strategy as the value of the call deteriorates as you approach the expiration date for the call option.
The naked call strategy, or the short call strategy, is a bearish strategy that is considered to be somewhat of an advanced strategy by most stock brokers. The strategy is used when a trader believes that a stock is going to decline and you allow another trader to sell you a call option which is where you get the premium from that option. You do this because you feel the stock will fall and it allows the other trader to hedge his risk by selling you the call option. Time decay works for you in this trade but your reward is limited to the call option premium while your risk is almost unlimited if the stock rallies.
The long put option strategy is similar to the long call except you are bearish on a stock. When you go long a put it means you are buying a put option that controls 100 shares of a stock because you believe the stock is going to decline in value. Your risk is limited to the premium paid for the put option while your reward potential is almost unlimited. Time decay works against you on this strategy so if you use it be sure to give yourself enough time to profit.
The short put strategy, also called the naked put strategy, is used when you are expecting a stock to rise in price or remain at near the same price level for a given amount of time. Your reward is the cost of the put option if the stock rises or remains static but your risk is theoretically unlimited if the stock declines. If it falls in price and hits your stop loss point you must buy back the puts to limit your risk. This is a bullish strategy that is a short term income generator when used properly.
By gaining a deep understanding of these four stock option trading strategies you will have the foundation to having mastery of them for huge returns. You will not only gain mastery over them by trading them effectively as individual strategies but you will begin to understand how to combine them which will let you control your risk while putting yourself in the best possible position for big profits. There are over 70 option strategies to trade for superior returns in today's markets and you learn how to use them all for your advantage but it all starts with these four basic strategies detailed here.
