Options Investing As An Income Generating Strategy
Considering the overhead costs that Marco Polo must have incurred on his camel rides to trade in silk it is not altogether surprising that he decided to stay in China for forty years after he arrived there. His overhead costs would have been high. By contrast, modern options trading allows for considerable profit and the overhead costs are relatively slight.
Stock options are contracts that are made between buyers and sellers. It is the contracts that are traded as objects. Each contract allows the owner to buy or sell an underlying asset such as a large mining company, commercial or financial organization that is constituted as a company. Commodity options on goods such as gold or oil may also be traded.
Such contracts are called derivative contracts because they are derived from trade in the stocks upon which they are based. Market makers create these contracts and take a premium on top of the buyer’s price. This is one way in which banks make their profits whilst transferring most of the risk from themselves to traders.
Traders accept the risk because they hope to profit from leveraging. Instead of using a large amount of capital to purchase a share in a company they have to outlay a small amount for a potentially larger profit. This is their way to leverage a large profit than would be the case if they bought only a few shares in the underlying asset.
For example, it could cost a thousand dollars to buy an underlying share but only one hundred dollars to buy a derivative contract that will provide for six or seven times the profit that could be had from buying the underlying share. Sadly, the lever can be applied in the reverse way should the trade turn sour and loss could also be six or seven times greater.
In addition to leveraging this form of trading also allows flexibility. If a trader believes that a share is likely to decline he may buy a ‘put’ option which gives him the right to sell it. If his prediction is correct and the price continues to decline after he has bought the put he may sell it at a yet lower price, his profit being calculated from the additional amount that the price has fallen.
In some quarters put options are condemned as artificial ways in which stock markets can decline precipitately due to the number of traders jumping onto the ‘sell’ bandwagon. Others believe that put options act as safety valves that prevent disasters such as the Great Depression. This is because a put option will be sold at some point and the sale will mean that another trader has taken an opposite view, so helping to maintain a balance.
The opposite of a put is a call option. This confers the right to buy the underlying stock. If a trader believes that a price will rise he buys a call and hopes to profit from the rise in price if the underlying asset.
Many different types of trading are possible. Some traders buy vegetables, divide them up into small packets and sell them at a profit. This is done at streets levels and in large supermarkets. Large amounts of stock must be held, and overheads include salaries, rates, rents and the like. Options trading involves few overheads and the real opportunity to make more profit than loss.
To learn more option trading tips take a look at KMX covered calls.
Popularity: 1% [?]
