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Understanding Stock Options Trading
and Technical Analysis Basics |
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"I've always been confused about options trading...
at least now I have a better understanding about it!"
Ben Masters
VIC, Australia
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> Options Guide > What
are options - Starting stock options |
What are Options?
Starting Stock Options
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For beginners, starting stock options can be very
daunting, with all the new terms and concepts. This
guide will hopefully shed some light on options
for you with its simpler explanations.
Options are another form of security that you can
invest and trade in the stock market. Like futures,
they are considered derivatives of - or based on
- normal stocks.
In the United States, options are traded via
Options Exchanges, the first and biggest of
which is the Chicago Board Options Exchange
(CBOE). For more information on what
Options Exchanges do, their history and their
current initiatives, visit the CBOE
website at http://www.cboe.com/.
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Options
are securities derived from
- or based on - normal stocks.
They are traded on Options Exchanges.
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Buying
an option gives you the right, but not the
requirement or obligation, to buy an underlying
stock at a specified price at a later specified
date. For example, you can buy an option to
buy shares in Microsoft in say 2
months' time at a predefined price.
The most widely used method of explaining
this is via the housing industry:
Imagine that you just found your dream home,
but can't afford the $100,000 you need to
buy it today. You then contact the owner,
and the both of you agree to a contract where
you get the right to buy the house in 6 months'
time at say $110,000 (taking into account
the rising cost of housing).
However, since you could possibly run away
without buying the house, leaving the owner
waiting 6 months for nothing, you agree to
pay him a token "downpayment" or
premium, of $5,000 for the right to buy his
house.
So, fast-forward 6 months. No matter what
the new market value of the house is, you
have the right to buy the house at $110,000.
2 things can happen: the market value of the
house could have skyrocketed to $200,000.
In this case, you still get to buy it at $110,000,
keeping the rest as profit (or savings, depending
on how you look at it).
On the other hand, if the price of the house
drops to $80,000, you can decide not to buy
it, since you have the right, but not the
obligation, to buy it. So all you've lost
is the initial $5,000 premium you spent to
lock in the contract.
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When you
buy an option, you get the right,
but not the obligation, to buy the
related stock at a future date,
but at a price you specify now.
If the stock's market value rises
above your agreed-upon price, you
profit. If the stock's value
crashes, all you've lost
is your premium.
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| All stock options trading
and technical analysis information on this website is for educational
purposes only. While it is believed to be accurate, it should not be considered
solely reliable for use in making actual investment decisions.
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