Skip to content

Getting acquainted with options trading

There's a common misconception that options are confusing and overly complex, but that simply isn't the case. Thank you This article has been sent to. And options market-makers make their living by selling options to retail investors and other people that want them like you, so connect the dots. Email address must be 5 characters at minimum. The challenge is remaining calm when all others are losing their heads.

Assuming I enter a stock at $/share. The stock goes up 3% over the course of two days, I then sell the stock and collect my profits. How would this compare to me buying a call option contract fo.


When managed properly, these benefits can help pay for future college expenses, retirement, or even a vacation home. But many investors get tripped up, don't pay attention to critical dates, and haphazardly manage their employee stock option grants. As a result, they may lose out on the many benefits these stock option plans can provide. To help ensure that you maximize your stock option benefits, avoid making these 6 common mistakes:.

A stock option grant provides an opportunity to buy a predetermined number of shares of your employer's company stock at a pre-established price, known as the exercise or strike price.

Typically, there is a vesting period ranging from 1 to 4 years, and you may have up to 10 years in which to exercise your options to buy the stock.

A stock option is considered "in the money" when the underyling stock is trading above the original strike price. You may be tempted to delay exercising your stock options as long as possible in the hope that the company's stock price continues to go up.

Delaying will allow you to postpone any tax impact of the exchange, and could increase the gains you realize if you exercise and then sell the shares. But stock option grants are a use-it-or-lose it proposition, which means you must exercise your options before the end of the expiration period. If you don't act in time, you forfeit your opportunity to exercise the option and buy the stock at the strike price. When this happens, you could end up leaving money on the table, with no recourse.

In some cases, in-the-money options expire worthless because employees simply forget about the deadline. In other cases, employees may plan to exercise on the last possible day, but may get distracted and therefore fail to take necessary action. Monitor your vesting schedule, keep your contact information updated, and respond to any reminders you receive from your employer or stock plan administrator.

There are 2 kinds of stock option grants: When you receive an ISO grant, there's no immediate tax effect and you do not have to pay regular income taxes when you exercise your options, although the value of the discount your employer provided and the gain may be subject to alternative minimum tax AMT.

However, when you sell shares of the stock, you'll be required to pay capital gains taxes, assuming you sold the shares at a price higher than your strike price. To qualify for the long-term capital gains rate, you must hold your shares at least 1 year from the date of the exercise and 2 years from the grant date.

If you sell ISO shares before the required holding period, this is known as a disqualifying disposition. In such a case, the difference between the fair market value of the stock at exercise the strike price and the grant price—or the entire amount of gain on the sale, if less—will be taxed as ordinary income, and any remaining gain is taxed as a capital gain. For most people, their ordinary income tax rate is higher than the long-term capital gains tax rate.

While taxes are important, they should not be your sole consideration. You also need to consider the risk that your company's stock price could decline from its current level. Consult with a tax advisor before you exercise options or sell company stock acquired through an equity compensation plan. Under most companies' stock plan rules, you will have no more than 90 days to exercise any existing stock option grants.

While you may receive a severance package that lasts 6 months or more, do not confuse the terms of that package with the expiration date on your stock option grants. If your company is acquired by a competitor or merges with another company, your vesting could be accelerated.

In some cases, you might have the opportunity to immediately exercise your options. However, be sure to check the terms of the merger or acquisition before acting.

Find out if the options you own in your current company's stock will be converted to options to acquire shares in the new company.

Contact HR for details on your stock option grants before you leave your employer, or if your company merges with another company. Earning compensation in the form of company stock or options to buy company stock can be highly lucrative, especially when you work for a company whose stock price has been rising for a long time. At the same time, you should consider whether you have too much of your personal wealth tied to a single stock.

There are 2 main reasons. With a stock, you could choose to buy and hold forever Buffett style , and even if you are wrong for 5 years, your unrealized losses can suddenly become realized profits if the shares finally start to rise 6 years later. But with options, the profits and losses become very final very quickly. As a professional options trader, the single best piece of advice I can give to investors dabbling in options for the first time is to only purchase significantly ITM in-the-money options, for both calls and puts.

Do a web search on "in-the-money options" to see what calls or puts qualify. Also, by being fairly deep in-the-money, you reduce the constant bleed in value as you wait for the expected move to happen the market moves sideways more than people usually expect.

Fairly- to deeply-ITM options are the ones that options market-makers like least to trade in, because they offer neither large nor "easy" premiums. And options market-makers make their living by selling options to retail investors and other people that want them like you, so connect the dots. By trading only ITM options until you become quite experienced, you are minimizing your chances of being the average sucker all else equal. The problem here is that your significant time value is bleeding away slowly every day you wait.

With an ITM option, your intrinsic value is not bleeding out at all. Only the relatively smaller time value of the option is at risk. Thus my recommendation to initially deal only in fairly- to deeply-ITM options with expirations of months out, depending on how daring you wish to be with your move timing.

By clicking "Post Your Answer", you acknowledge that you have read our updated terms of service , privacy policy and cookie policy , and that your continued use of the website is subject to these policies.

Questions Tags Users Badges Unanswered. Options vs Stocks which is more profitable. I appreciate any clarification. AnchovyLegend 1 1 9. The very simple answer is that options are much more highly leveraged than stocks. If you buy the option and the stock goes up now, before expiration you make a lot more money. If it doesn't go up before expiration, you lose everything.

If you buy the stock and it doesn't move, you don't lose anything. If you buy the stock and it goes up, you gain the small percentage.

This is all before allowing for commissions. RossMillikan I think your comment might be the best answer posted so far. Kep in mind that there is massive arbitrage. If one type of investment would certainly be more profitable than another, arbitrage would quickly erase the difference. This is one of the hidden benefits of High Frequency Trading - it greatly reduces the chance that you're buying too high or selling too low.

A bot would have undercut high sellers and outbid low buyers. MSalters - for a rising stock, a leveraged position " would certainly be more profitable than" one that's unleveraged. No idea why you think arbitrage would somehow change this.

The buyer of an option cannot lose more than the initial premium paid for the contract, no matter what happens to the underlying security.

So, the risk to the buyer is never more than the amount paid for the option. The profit potential, on the other hand, is theoretically unlimited.

In return for the premium received from the buyer, the seller of an option assumes the risk of having to deliver if a call option or taking delivery if a put option of the shares of the stock. Unless that option is covered by another option or a position in the underlying stock, the seller's loss can be open-ended, meaning the seller can lose much more than the original premium received.

You should be aware that there are two basic styles of options: Most exchange-traded options are American style, and all stock options are American style. Many index options are European style.

When the strike price of a call option is above the current price of the stock, the call is out of the money ; when the strike price is below the stock's price, it is in the money. Put options are the exact opposite, i. Note that options are not available at just any price. Also, only strike prices within a reasonable range around the current stock price are generally traded. Far in- or out-of-the-money options might not be available.

All stock options expire on a certain date, called the expiration date. For normal listed options , this can be up to nine months from the date the options are first listed for trading.

Key takeaways

The two types of options are calls and puts. When you buy a call option, you have the right but not the obligation to purchase a stock at the strike price any time before the option expires. When. Options prices are often sharply higher after panicky stock investors rush to buy bearish puts to hedge their stocks. The rush to hedge, coupled with sharp stock . When taking stock of how to invest in the market, you have options — both literally and figuratively. You can buy stocks, which represent shares of ownership in individual companies, or options.