With the increasing selection of financial investments, many small investors are diversifying their portfolios through the inclusion of stock options. Many people who are not dedicated investors are nevertheless familiar with company stock options as a method employers use to share profits and reward performance.
It’s important for the small investor to realize that stock option investments carry greater risks when purchased privately outside the scope of employment compensation. Instead of the company providing a bonus of its own stock options, where the risk of loss to the employee is nil, small investors who purchase stock options on their own bear the full brunt of any loss. Therefore, it is critically important that small, private investors gain a thorough stock option education before making any significant investments.
Whether purchased by the company, or purchased privately, stock options are nothing more than stock shares wrapped in a contract describing the manner in which the shares may be bought or sold. These contracts are called option trading contracts. Option trading contracts give the buyer the right, but not the obligation, to purchase or sell the described stock shares at an agreed price within a specific time period.
Call options and put options are the two major kinds of option trading contracts. Call options are contracts to buy underlying stock shares; put options are contracts to sell them. The call options designate the holding of a long position on the aforementioned stock, but the put options symbolize the short position.
Buying a call option is the same as betting that the price of the stock will rise. Buying a put option is the same as betting that the price of the stock will fall, but in both cases it must happen before the option expires. One option strategy is to buy a combination of puts and calls on the same stock in order to limit losses and potential gains when the price makes a large move.
Option contracts, although typically applied to stock shares, may also be applied to any other kind of asset, such as commodities. Through option trading, the educated investor can create profit opportunities in any market, no matter which direction the asset price or broader market takes. Stock option trading is therefore more flexible, but more complicated, than trading stocks themselves.
There is a greater risk to a small investor when they purchase stock options on their own without an option strategy. Stock option education is necessary for any small investor before they make a large investment. What is nice about stock options is that they are shares that are wrapped in contracts that help to define how the share can be bought or sold. Called option trading contracts, they are what define the stock options. They give the purchaser the ability to buy or sell the stock shares at a price and time agreed upon in the contract.
- David Baxwell
This entry was posted on Sunday, March 22nd, 2009 at 12:03 am and is filed under Finance. You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.
