Stock options provide a great opportunity to profit in the stock market. The use of stock options is often times misunderstood. For this reason some of the basics of using stock options should be covered in order place you all on the road to successful trading.
Stock option traders have different ideas about the level of risk associated with options trading. Levels of risk come in a couple of different types. The first type of risk would be in the amount of capital risked in a particular trade. The second type of risk would be in the probability of obtaining a positive return.
Stock options are often chosen because they provide a level of leverage as well as a level of limited risk. For instance, if you purchase a stock option for $1000 then no matter what the market does that $1000 is all that you can lose. This is an example of the first type of risk in stock option trading. Stock options are a decaying asset, in other words when you buy a stock option it has time value associated with it. This time value decreases as the option moves closer and closer to it's expiration date. It is because of this time value that many options expire worthless. This is an example of the second type of risk, where you have to look at the probability of the positive return within a restricted time frame
The fact that you have a limited amount of time for your option to increase in value means that you also must be more accurate in choosing direction than you would if you had simply purchased stock. Let's say you bought an option that expires in three months, that is basically the amount of time you are limited to to make a profit on your option. Conversely, if you had owned the stock. Then you have a virtually limitless amount of time in which to turn a profit unless of course the company goes belly up.
So remember, if you are going to trade options that even though your total risk is limited to the amount you paid for the options that the time frame in which you have to profit is much more limited than if you owned the stock itself.
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