Overview
Option trading is a type of investment that is
very popular, and it is done both in the stock exchange and by private
agreement. When you trade options, you make an agreement with someone
that you will buy a particular number of shares of a stock that they are
selling on a specific date for a certain price. You pay them an option
premium, which is an amount of money that gives you the right to buy
those shares at that time, at the particular price.
Option trading is much like commodity futures trading, except that
when you trade futures you are obliged to make the purchase based on the
contract you agreed upon and make a down payment. With option trading,
you can make the purchase or even let the option expire, depending on
which one will earn you more profit.How It Works
Most options trading are done through a public exchange, where you don't know who the seller is. When you trade options, you pay an option premium for the right to purchase a set number of shares from a seller for a particular amount of money per share. When that date comes, if the shares of that stock are selling for higher than you agreed upon, you would make the purchase. You can then immediately resell those shares at the current market price, making an instant profit.If the shares of that stock are selling lower than you agreed to pay for them, you could decide not to make the purchase and you therefore let the option expire. If you were to buy the shares, you would be paying much more than the current market price. You can instead buy the shares cheaper in the open market. When you let the option expire, your only loss is the amount of the option premium you paid to hold those shares for you and that becomes the seller's profit in that trade.