Stocks can really be a great place to grow your wealth. So, if you are making money by trading stocks there is a fantastic way of increasing your returns. But if you don’t have a plan they can take your account to 0.
This is called stock options. What is a stock option? Options give you the right to buy/sell a given stock at a given price on or before a given date. Let’s say that whatever indicators you are using are telling you that stock XYZ is probably going to go up.
If stock XYZ is trading at $87 the first thing you can do is to simply buy it at $87. A second option would be to invest into the $85 call option set to expire in 3 months. This cost you $8. With the call option you buy the right to buy the stock at $85 before the option expires in 2 months.
If the stock goes up to say $100 that means you have made at least $15 because your option would be worth at least $15 ($!00-$85). Because the option was originally bought for $8 that would mean a 87.5% profit. The stock by comparison would have only given you a little above a 17% return from the same move.
There is no doubt that options are powerful, but they can also work against you. If the stock fell down to $84 and your call option expired worthless you would have lost 100% of your initial investment. Compare that with the stock, which was only down 3.4%.
So, option trading is not without it’s flaws. This is why, when it comes to options, one of the best stock market tips you will get is to only start trading options after you are making money trading stocks. Stock options can make you a lot of money, but in the end all they do is magnify what you are doing already.
So, if this is something that you are interesting in the next question is, how do I buy stock options? Pretty much any online brokerage will be able to buy options. However most brokers require you to be approved for option trading before they will let you trade them.
In most cases this means that you will have to have some experience trading stocks first. Really this is the best way to go. You don’t want to jump into this strategy unless you are already used to managing risk and picking trades. Basically stock options are just more leveraged investments for experienced investors. If done right they can be worth it.
