There are abundant of money in the stock market. However, not
everybody can get the money out from there. Some people can gain a lot
from the stock market but some has lost a lot of money there. It is
very indecisive. Sometime at that moment, you loss money but after a
few days, you may earn a profit and sometime is reverse. So, how should
we do to get the money out from the stock market? Usually, there are
two ways to get the money out from the stock market; that are investing
and trading. The difference between trading and investing is trading
involves buying and selling share, future or option within a short
period of time; whereas investing is buying share, future or option and
hold it for quite a long time, usually one year or more before selling
it.
What is the difference between share, future and option? What
we know is that option is much cheaper than the share and future,
usually is tenfold lesser than the share price. So, if you have an
amount of money that enough for you to buy 100 units share, you can use
that amount of money to buy 1000 units option. And the return of
investment is almost the same between share and option. Therefore, you
will earn around tenfold if you buy option rather than share or future.
However, the disadvantage is that if you lose on that trade, you will
lose almost tenfold also. When we trade option, the amount of money
that we can profit and lose is almost same as if we trade share.
However, we need a lot of money to buy share compared to buy option.
This causes the percentage of the profit and loss for buying option is
much higher than share. The example is like when you buy $10 for one
unit of share and $1 for one unit of option. When the share price drops
for %ARTICLEBODY%.10, the percent drop for buying share is 1% but for
buying option, the percent loss is 10%. That?s why the percentage of
the profit and loss for buying option is huge compared to buying share
even though the share price fluctuates in a small amount.
Due to
the high profit and loss when buying option, trading or investing
option is just like gambling. It is quite normal that the return of
investment is more than 100%. But it is also quite normal that you
could lose all your money in the investment or trading. In order that
you can earn more than lose, you need to know some basic option trading
strategy and technical analysis. Option is different from the share.
Option has time value; whereas, share does not have time value. The
value of one share will not depreciate due to the passage of the time.
It is only affected by the supply and demand and also the company
performance. However, option value will depreciate when the time has
passed. When the time reaches to the option expiration date, there is
no more time value for that option. That?s why, you need to use
strategy to trade option, in order that you can minimize the loss and
maximize the profit.
The very basic two option trading strategies
are bullish call spread and bearish put spread. Bullish call spread is
used when the stock price is anticipated to rise in the coming months;
while, bearish put spread is used when the stock price is anticipated
to drop in the coming months. Steps that are involved in this strategy
are buying in the money option and selling out of the money option. In
the money option is the option that has time value and intrinsic value;
whereas, out of the money option only has time value. When the stock
price moves to the positive side (generated money side), in the money
option will generate profit and the out of the money option will cause
loss. However, the minus of the profit and the loss is the net profit
that has generated from this strategy. When the stock price moves over
the out of the money strike price, the profit will become maximized.
Continuously moving of the stock price to the positive side will not
generate any profit. In this situation, we will close both positions to
take the profit out from the market.
If the stock price moves to
negative side (opposite side that cause loss), in the money option?s
value will depreciate and the out of the money option will generate
profit. However, the profit, which is generated from the out of the
money, is limited to the price that you have sold. The subtraction
between out of the money?s profit and in the money?s loss is a negative
value. This is because the profit that is generated from the out of the
money option is less than the loss that is caused by in the money
option. Out of the money option?s profit is limited in this strategy
and in the money option?s loss is unlimited. If the stock price
continuously moves to the negative side, you may lose all of your
capital. So, what is the difference from buying naked option and buying
option using spread strategy? The difference is that you may lose more
money if you buy naked option and lose less money if you buy spread.
This is because you do not generate any profit when you just buy naked
option; whereas, profit is generated from the out of the money option
if the stock price moves to the negative side. The disadvantage of the
spread is that the commission, which is charged by the broker firm, is
double compared to the naked option. This is because, naked option only
involves one position; whereas, spread involves two positions. Each
position will be charged with commission separately.
Besides, the
purpose of selling out of the money option in the spread strategy is to
minimize the loss of the time value of the in the money option.
Actually, both in and out the money option?s time value would
depreciate when the time has passed. Because we do not own the out of
the money option; therefore, we can keep the money that we have
received from selling that option. When the time value of this out of
the money option has depreciated, we used lower price to buy back the
option. So, we sell at high price and buy back at low price; therefore,
we earn money. The money that we have earned usually is enough to cover
the loss of the time value from the in the money option. However, you
still lose the intrinsic value of option if the stock price moves to
the negative direction.
So, bullish call and bearish put spreads
are two of the very basic option trading strategies. However, it is not
guaranteed 100 % win from the stock market. You still need to learn to
predict the stock price direction accurately using technical,
fundamental and news analysis.
By Alexander Chong
Author of "Workable Option Trading Strategies"
http://www.makemoneystocks.com/
