Options Trading Tutorial

What is an options trade in terms of the stock market?

I recently opened an account with TradeKing, and I was wondering what an options trade is. Also, why would people want to sell options rather than sell the stock at its market value? Thanks.

Public Comments

1. I do a little bit of options writing. Take company XYZ trading at 20$. I buy 100 shares, one options contract represents 100 shares. I think the stock could move up a little bit, but I think maybe the company will move sideways. I can write a covered call, covered means I own the stock and am writing against the stock I own. I think it might get up to $21.50. I write a call contract with a strike price of $22 for maybe $0.75 ( thats 0.75 * 100 = $75). I buy $2000 worth of stock and I can collect $75 a month while it is doing nothing. The stock stay under my strike price, the contract expires and I keep the stock and $75. Or, the stock could go up to say $23, they beat expectations on an earnings call or something like that. By selling that contract I have sold the right for them to buy that stock at $22. I paid $2000, collect $75 on the option contract and was forced to sell my 100 shares for $2200. I keep the $75 and collect the $2200 and make a total profit before tax and fees of $275. Or, the stock could go down to say $18. Since I sold that $75 call contract I've off-set my loss my $75 and cut my loss to $125 instead of $200. You are limiting your upside and cushioning the downside. Some of the bigger funds do it to free up cash. They can lock in a purchase price for $1 a share and use their cash elsewhere. It is a leveraged position. Additional note: If your looking to just straight out trade options. Keep an eye on the Delta and Theta. Delta is the the change in the value of the option relative to the underlying stock price. If you buy and a call contract with a Delta of 0.25 for every dollar the stock moves up the value of the contract goes up $0.25. Theta is the time decay value a Theta of 0.05 means that every days the value of the contract losses $0.05. So be careful high theta and high delta can cost you big money in a hurry.
2. An option is a contract to buy or sell 100 shares of a stock at a specific price anytime before a specific date. For instance, an option to buy 100 shares of yahoo at $20/share any day before January 2011. The reason you trade options is b/c it is leveraged, meaning you can control 100 shares of yahoo for less money than it would cost to buy 100 shares. For instance, if yahoo trades at $15/share, you need $1500 to control 100 shares of yahoo if you buy it outright. If you buy options of yahoo, they might cost $4, so you would only need $400 to control 100 shares.
3. An "option" give the right to buy or sell shares but not the obligation. Options can be profitable, break even, or unprofitable.