Saturday, February 25, 2012

Increasing Your Financial Prospects With Options

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By Robert Williams


The stock market industry is rife with terminology that can be confusing. Understanding not only the terms, but how each of the products can be used, is an important part of the excitement of being involved in taking risks that can provide significant rewards. Options are products that can be lucrative or can be costly, as all ventures into the market, and should only be used when the investor is experienced.

Derivatives are a product sold that relies on the value of an associated product. Options are contracts that rely on the price of the associated stock and are considered derivatives. The contract allows for purchasing the underlying stock at a pre-determined price before a pre-determined date. The more informed investors use market language to make the same statement. The writer sells a contract enabling the buyer to call or put at the strike price before the exercise date.

Options are divided into four categories. They include buyers and sellers of calls as well as buyers and sellers of puts. Those who purchase calls believe that the underlying stock price will increase. Those who sell calls receive a premium for the contract and are obligated to sell if the strike price is met on the exercise date.

If the investor believes the price will go down, they purchase a put. Those who sell puts receive a premium and must purchase when the strike price is met. All investors should do research into companies involved, the stock market status and any other issues that might factor into changes in prices.

Investors who own the underlying stock and write calls do so to generate more profit. Covered calls are the safest of the different types of options and are considered to be conservative. Writing a covered call generates a premium. The contract sells the right to purchase stocks in the investor's possession when it hits the strike price.

Both companies and individual investors use this took to protect their portfolios against significant loss. It is much safer to use them this way, than as a speculative vehicle. Hedging acts as an insurance against significant losses. While the cost of the option still affects profits, if the market is volatile there could be much greater loss.

Speculators are high risk takers and use options to increase their potential for high earnings. But this same risk can cause huge deficits as well. When attempting to speculate, the investor must be educated about several variables. The variables include the price change, how much it will be and when it will change. They must be well informed about the risks and have experience reading the market.

No one new to the stock market or to these products should make significant investments in this product. They are extremely volatile and should only be considered with advice from an expert. While safest option is a covered call, if it is not executed properly, or if the market is volatile, it can still entail a loss.




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