Understanding
Stock Options Trading
and Technical Analysis Basics


Frequently Asked Questions



What is the Option Trading Guide?

This site is a growing resource aimed at providing you with graphical and easy-to-understand guides on the basics of stock option trading, as well as more advanced trading strategies and technical analysis concepts and indicators.

 

What are stock options?

In the context of option trading, stock options are NOT the employee stock options given by companies to their employees in lieu of (or in addition to) standard remuneration. Stock options here refer to a form of trading derivative based on publicly traded stock equity.

Buying an option gives you the right (but not the obligation) to buy or sell its related stock at a specified future date. A Call option gives you the right to buy its related stock, while a Put option gives you the right to sell its related stock. Investors trade with options because they can leverage and take advantage of the cheaper cost of options while receiving the full gain (and loss) associated with trading the related stock.

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What are all these option strategies with funny names (such as the Iron Condor)?

The concept of option trading really boils down to the basics of buying and selling Call and Put options. However, you can create various combinations of these basic options to match whatever profit and risk profiles you want.

While the basic Call option is for when you expect the stock price to go up and the basic Put option is for when you expect it to go down, you can create strategies that fit any projected price movement you can think of. These strategies may involve buying more of one option, or buying one option and selling another, or buying options with different target prices and expiry dates.

The names given to these option strategies usually refer to what they do or what the profit graph looks like. For example, the profit graphs of the Butterfly and Saddle option strategies look like a butterfly and a saddle respectively.

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What is technical analysis and how is it related to option trading?

There are a few methods investors use to determine whether an option or stock is worth buying, and how long they should hold on to it. These methods usually fall under two headings: Fundamental Analysis and Technical Analysis.

Fundamental analysis involves researching the overall health of the company in question and the likelihood of it growing or declining. This research is based on the company's past financial data and its forecast results and earnings. Common fundamental indicators include the Price per Earnings Ratio which indicates how undervalued or overvalued a stock is, as well as the company's projected growth rate and dividend yield.

Technical analysis is substantially different, and focuses on stock price movement trends, momentum and investor emotion. Technical analysts will look at a stock's financial charts and analyze the price movement and volatility. They will use this data to infer how strong the current trend is and how far it will go, as well as try to predict when the price will start to fall. Technical indicators include the MACD indicator that measures momentum, and chart analysis tools such as Candlesticks and Bollinger Bands to predict future price movement.

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How do I get started trading?

It must be stressed that option trading is a very risky exercise and you can potentially lose your entire investment (and more) if you are not careful. We recommend that you spend a few months paper trading (i.e. go through the process of researching stocks and buying/selling options without actually investing any money). You should only start trading options using real money when you are confident of your knowledge in option trading.

You can also read up on the various strategies and techniques. A good place to start would be our Option Basics Guide, Advanced Strategies section, Technical Analysis Guide and Resource Library. We don't presume to cover every topic related to option trading though, as there is a whole world of ever-changing information out there relating to this industry. If you are interested in learning more, you can always pick up some books from Amazon.

 

Best of luck!

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