Making money with options

Options are derivatives in the stock markets. They are easy to understand once you understand the basic principal behind them.

In simple words an option can be defined as such

An options contract is an agreement between a buyer and seller that gives the purchaser of the option the right to buy or sell a particular asset at a later date at an agreed upon price.

In simpler words , an option is like insurance. Just like one can buy or sell insurance, one can buy or sell options in the stock market. Options are of two types, named call option and put option. To make things easy to understand enumerating four basic alternatives below

  1. Buying a call option will generate income if the underlying asset(stock or index) rises.(In case the asset falls , the maximum loss is the price of the call option)
  2. Buying a put option will generate income if the underlying asset (stock or index) falls.(In case the asset rises , the maximum loss is the price of the put option)
  3. Selling a call option will generate income if the underlying asset (stock or index ) falls or stays at same level. (In this case the loss is unlimited in case the underlying asset rises.)
  4. Selling a put option will generate income if the underlying asset (stock or index) rises or stays at same level(In this case the loss is unlimited in case the underlying asset falls)

Once you understand above , rest is easy.

Options can be used for
1. hedging (hedge funds use this) you simple sell a call option against the stock you are holding. These are also called covered calls. This generates an income on a monthly basis . However you need to understand the pitfalls too.

2. Buying options in the direction you think the markets or stock will go.                                                         These are like lottery tickets. However buyer of lottery tickets rarely win .

3. Selling options in the direction you think the markets or stock will go.   The pitfall is that in case your direction goes wrong you can lose your shirt.

Ultimately knowledge and experience  always wins. Half knowledge is always dangerous and one must strive to learn from the experience of  known success stories.

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