Stock Options Guide

Can Stock Options Help Your Portfolio?

Many investors follow the commonly-recommended strategy of investing for the long haul. By dollar cost averaging a variety of stock and mutual fund purchases over time, they can build a nice nest egg for retirement. When the Internet came along, however, many longer-term investors turned to online trading as a supplement to their retirement investments. In some cases, people turned to trading as a full time occupation. Many of those traders who needed current income turned to trading stock options.

The options market carries a much larger financial risk that many longer term investors aren't prepared to accept. Stock options, as the name implies, are contracts that allow you to buy or sell a fixed amount of shares of stock at a fixed price by a specified deadline. Stock options are said to be 'in the money' if exercising them would generate a profit relative to the stocks price at the point the option is exercised. For example, if a stock is valued at $45 per share, and you own an option to buy 100 shares at $40, that option is in the money for $5 per share, or a total of $500. That is also known as the intrinsic value of an option. Additionally, an option carries a time value. This means the option has an extra value associated with it to reward the option seller for taking the risk. Over time, this value decays, and that is where much of the seller's profit is generated.

The extra risk then is because of the time factor. When buying actual stock, an investor needs to be correct about the price of the stock, and not much else. That's sometimes hard enough, but when trading stock option, the successful investor also has to be correct about how much the price will change, and the time frame within which the change will occur.

Stock option can be successfully traded as a small portion of your overall investment portfolio. Before you do that, be sure you understand the nature of the game - it's not as easy as you might think.

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