I’m sure you’ve wondered; how do investors make money in stocks with options trading?
You’ve probably heard that this way of trading stocks can be quite lucrative. Yeah, that’s right, people can make money whether stocks are going up or down.
But hang on a second.
While it’s true that you can make money investing in stocks using options, you can also lose your shirt. (You can lose your pants, underwear, and everything else too if you don’t know what you’re doing.)
However, you can make a lot of money investing in options while reducing your chances of losing your money – IF YOU KNOW WHAT YOU’RE DOING.
In this Options Training for Beginner’s lesson, we’re going to simplify and demystify the process of what Call Options are. In other lessons, we will learn Put Options, Strike Prices, and other important topics related to options trading.
But here’s the thing.
You probably won’t make a killing with this investment vehicle right off the bat. It takes time to learn this method of stock investing. But you can make money with practice, study, research, and patience.
So, let’s get started, shall we?
Options Trading for Beginners – What is a Stock?
I’m going to go over the basics in this lesson of options trading for beginners just in case you are totally new to investing in the stock market. To make sure you understand stocks, I’m going to go over the very basics first to make sure you understand exactly what I’m talking about.
However, if you’ve been trading for awhile you can skip down to the call options part.
A stock is an investment vehicle that lets you buy into a part of a company.
So, if I have a lemonade stand and you notice that I’m making a killing selling lemonade you might take notice and say, “ Hey, how can I participate in your business and make a little money on the side with you? I already have a job, so I can’t actually be here to help you. How can I make money from your lemonade venture without actually being at your stand?”
Then I’d tell you that other people have said the same thing and they are handing me money to invest in my lemonade business. So, you hand me $10 and I hand you a legal piece of paper called a stock that says you own a part of my business.
Later on, I sell more lemonade, and more people have bought into my lemon- based business. I now have enough money to purchase a small shop to sell it out of. Because my business is doing better (a lot more customers, more profits, and more stock investors) your stock is a lot more valuable. People now want to buy stocks in my business at a higher price. That means that your stock is more valuable and you can sell it at a higher price determined by the demand of other investors. This price is called “market value” because all the other investors who are buying my stock at a higher price are causing the price of my lemonade stocks to go up.
This is in contrast to one of my competitors – Joey Bladderworst, who had a lemonade stand down the street. He was doing great and he started selling stocks to his investors too. (These investors are called “stock holders” or just “holders”.) He was doing so well that investors were buying stocks from him 3 and 4 at a time. So, the value of the stocks went up as well as the price. Soon he was selling his stocks at $15 a share.
However, one day a bird pooped into one of the glasses of lemonade he was selling and one of his best customers gagged on it. He lost all of his customers and his stock price dropped down to the price of bird poop overnight. Some of his investors caught wind of this early and sold their stocks at a loss of just a couple bucks. However, the rest of his investors who missed the news of this debacle got nothing when Joey’s business died.
I guess you need to keep an eye on your stock investments! Right?
Stocks Clearly Reviewed
So once again, a stock is an investment vehicle that lets you buy into a part of a company. It is the way a company raises additional funds so that it can invest it into things which will make the company even more profitable.
So, you buy a chunk of XYZ company by purchasing their stocks at the market value, and XYZ will invest that money into things like, fiber optic cables, better salesmen, delivery vans, whatever. This is done in the hope that the company will make more money and get bigger, thus making the stock go higher in price and become more valuable.
If XYZ company sold you a stock for $100 (called a share) and it becomes a more profitable company, the stock could rise to $200 a share.
You can sell your share when the stock goes up to $200 and make $100.
Of course, if the company has lousy management or a streak of bad luck, it is a less profitable company and your initial $100 could go down and you would lose money.
So, based on this, you are the buyer of the stock and the company (XYZ) has a stock (investment) or part of its company it wants to sell to you.
If you don’t understand what I just said, go back and reread the section on stocks again from the top.
What is an Option?
We have to start at the very basics in this options trading for beginners lesson, so even if you think you might know these terms and concepts, don’t skip them.
You may have learned them wrong, and it never hurts to go back and review key terms and concepts, does it?
An option is a contract (sometimes called a financial instrument) that lets you buy or sell a stock at a specific price within a specific time.
OK, stop and reread that a few times and take a breather.
Let’s break this small chunk of information about what an option is down even further.
- A contract is an agreement between 2 parties – the buyer and the seller.
- This contract gives you the option to buy or sell stocks at a specific price.
- You must purchase your option at an agreed-upon time. (Every stock option contract has an expiration date)
If you don’t understand these chunks, go back and reread them slowly.
Let’s Play a Stock Options Game
There are two basic kinds of options. One is a Call Option, and the other is a Put Option. Right now, we are only concerned with a Call Option.
In Figure 1 above, we can see the Options Game we are about to play. There is the beginning of this game (January 2021) and an end to this game (January 2022).
Look at the current stock price.
(Let’s call it XYZ Company’s Stock again.)
We can easily see that the current stock price for XYZ Company is $50.
So far so good — I knew you’d get this!
Now, let’s say you have zero stocks in the XYZ company. You don’t have to own any stocks at all for that matter.
All you’ll need is an account with a brokerage company to buy stocks or buy options. Let’s say for the sake of this scenario, you are brand new to the market and have no stocks at all and you just opened your new brokerage account today.
In May of 2021, you will have the option (not an obligation) to buy a stock option in XYZ company for $55. This option to buy the stock is good for the next 365 days.
See where there is a yellow square with $55 in it?
If this is January 2021 the price of the stock currently at $50 as you can see in the first green box.
Remember, you don’t have to own any of this stock initially or any other stocks for that matter.
So, going back to our Figure 1 scenario, you find out you can buy a stock option (buying a stock option is called “A Call) and you decide to buy it at a Strike Price of $55.
You don’t have to wait until May to buy it you can buy it as soon as it is offered. So, let us say that it’s still January 2021 and you make a Call on an Option to buy stocks from XYZ Company at the Strike Price of $55.
(You’ll also have to pay a fee for buying the stock option. In this case, let’s say it’s a mere $0.20 cents.)
Now here is where the real fun of using a Call on an Option comes in.
Now here is where the real fun of using a Call on an Option comes in.
Take a look at Figure 2.
You can see by this diagram that stocks can go either up or down. If the stock rises above the strike price it is called being “in the money” (See the green arrow.)
If the price of the falls below the strike price it is called being “out of the money” (See the red dotted arrow.)
Now, here’s the sweet part.
You already bought the option at $55.
If the price of the stock were to go to $60 you would make a profit of $5.00 minus the price of buying the option which was $0.20 cents, which gives you a profit of $4.80.
If the stock continues to rise within the 365 days ending on January 2022 you would continue to make higher profits.
Once the time period is over, (once again Jan 2022) the option is finished and you will have pocketed a tidy sum of money.
In other words, our game is over and you’re a winner.
If the stocks had traveled in the opposite direction you would have been “out of the money” and lost the money you put into it. In this case, it was only $0.20 cents.
However, you are about to find out it’s not that safe…
Enter the 100 Multiplier
Let’s learn a new rule for this game.
When you make a call option you can’t just buy one stock. (I just used one stock as a simplified example.)
In our original scenario, all you had to pay to get the strike price or option price was $55 plus a brokerage fee to create the contract.
However, in the real world of options investing, it’s a little more…shall we say…risky.
And the reason why it’s riskier is that you have to call or contract round lots of 100 shares in a stock option.
Take a look at Figure 3.
Now, look at Figure 4 below.
You will notice that Figure 4 is the same as Figure 2 but with one difference. We have added the multiplier of 100.
So now instead of paying just $55, you’re paying $5500.
Now I know that’s a real bummer. But every time the stock goes over your strike price of $55 you have to multiply that amount by 100. So, if the stock goes up to $60 you have to multiply that amount by 100.
In other words, your stock is now valued at $6000.
Wham-o, Bam-o! You just made a profit of $500! ($6000 minus $5500 = $500)
Notice: I would like to mention you’ll have to subtract the small brokerage fee from your profits. But it’s usually not much.
Important Questions About Call Options
What happens if the stock never goes over the strike price?
If the stock never goes over the strike price of $55, then you are out the entire $5500 you put into it in the first place. (Once again, you are also out of the small brokerage fee.)
Are all Call Option Contracts usually one year long?
No. I only used a year as a simple example. Usually, all stock Call Options have at least 4 expiration dates that you can choose from. These will be discussed and simplified in a lesson on that subject.
Is there only one strike price?
No. Once again, there are multiple strike prices that will occur on different dates. These too will be simplified and explained in another lesson.
The conclusion to Options Trading for Beginners | Call Options
Now you should have a clear understanding of the basics of call options. If you’re having a problem understanding these concepts, please go back and read this lesson again.
If you get stuck, call me!
Learning these options strategies and concepts on your own is not easy. If you want to learn how to invest and make money in securities, I’m available for consultations on a scheduled basis.
Learning how to invest in stocks is time-consuming. (Time is your most valuable asset because it is limited and you can never get it back.)
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Take a look at what some of my clients have said after working with me.
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