Learn to Trade Options: Simple Call and Put Buying

Breaking down basic option buying with options guru, Bernie Schaeffer

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    Trading options can be a complicated process as a lot of options strategies are available and traders need to evaluate all of the possible routes ahead of executing a trade. As such, Schaeffer's are starting a new educational series titled Optimizing Your Options Strategies. The beauty of options trading is that there are options strategies for every market environment. In this series, we will cover all available options strategies for an educated trader to consider when identifying trading opportunities.

    In this article, we will be talking about one of the most popular options strategies known as Long Calls and Puts. Buying calls and puts is one of the simplest ways to take advantage of the perks of options trading. Buying options allows traders to capitalize on the true power of convexity, leveraging truncated risk. What this means is that, when buying options, a trader's downside risk is capped at his initial investment but his upside potential on each trade is theoretically unlimited.

    Before learning the strategy, a trader must understand what an option is. An option is an equity that gives the option buyer the right, but not the obligation, to purchase the underlying stock at a specified price within a specified period of time. One option is representative of, usually, 100 shares of the underlying stock.

    A call option buyer profits when the underlying stock price increases in value, while a put option buyer profits when the underlying stock price decreases in value. The option buyer can exercise, or close his option position, at the current market price on or before the expiration of the option.

    A long naked option buying strategy, or simply buying either a call or a put, has its own benefit and drawbacks. A naked option purchase has unlimited profit potential because, theoretically, the stock can increase without a cap and options are leveraged off of stocks for exponential returns. However, with option buying, traders can expect a winning rate of just 35-50% with a profitable option buying approach. This is a hard-to-swallow statistic for many considering options trading, but must be understood before a trader attempts the usage of long calls and puts.

    The maximum amount of money you can lose when buying a call or a put option is the just the premium you paid for the trade. This means that you can only lose 100% of the money you put in the trade, also known as truncated risk.

    If you buy a call option, the breakeven price is your cost per share (premium) plus the strike price of the option. If you buy a put option, the breakeven price is your cost per share (premium) minus the strike price of the option.

    The Basics of Buying a Call Option

    Buying a call option gives the buyer the right to buy 100 shares of a company on a given date (also known as the option expiration date) at a specific price known as the strike price. If the price of the underlying stock goes up, then it's likely that the price of the call option contract will also go up, and if the price of the underlying stock goes down, then the price of the call option contract is also likely to go down.

    If you buy a call option, you can hold the contract till the expiration date, or you can exercise the options contract at anytime you see the opportunity to take profit or limit losses. At this time, the seller would need to sell his shares at the current market price.

    While buying call options, you pay the current market price for the right to the options contract which is called the option's premium. If the current price of the underlying stock is higher than the price of the underlying stock, plus the premium you paid for it, then you are in the profit zone for call buying.

    The Basics of Buying a Put Option

    Buying a put option gives the buyer the right to sell 100 shares of a company on a given date (also known as the option expiration date) at a specific price known as the strike price.

    If you buy a put option, you can hold the contract till the expiration date, or you can exercise the options contract at anytime you see the opportunity to take profit or limit losses. At that time, the seller would need to buy back your shares at the current market price.

    While buying put options, you pay a market price for the right to the options contract which is called the option's premiumIf the current price of the underlying stock is lower than the price of the underlying stock, plus the premium you paid for it, then you are in the profit zone for put buying.


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