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Options Basics

As well as trading bonds, stocks, an other investment types, more knowledgeable investors choose to buy or sell the option to trade securities at a specified date and at a specific price. Options are becoming more well known to independent investors, specifically due to increased understandings of market trends and the the general drive to make more money in less time.

In general, an option is the right to buy or sell a specific number of shares of a particular security at a fixed price up until a specified date. Options are legal and binding agreements between a buyer (holder) and a seller (writer) where the buyer agrees to pay a specified premium to the seller to take control of the underlying securities for a specified period of time. Because the buyer doesn't own shares of a stock and does not want to at current prices, they purchase the option to trade the stock.

There are two types of options: call and put. A call option gives the holder (buyer) the right to buy the underlying security at a specified price and requires the writer (seller) to sell at the specified price. A put option gives the holder the right to sell the underlying securities at a specified price and requires the writer to buy at that price.

Whether you are a buyer or a seller (holder or a writer), you have one of two thoughts about the market or the stock of interest: is it going to go up or is it going to go down? You may hear top traders use the terms bull and bear market. Generally, if you believe that the market or a securities price is headed upwards, you are bullish- you believe there is a bull market. However, if you believe that the market is headed down, you are bearish- you believe there is a bear market. This can be tricky, so read carefully.

The terms bull and bear are not quite intuitive applications at first thought. Way back when, "bear skin jobbers" were known to sell bear skins they did not own (p.s. the bears hadn't been caught yet). The term was eventually used to describe short sellers or speculators who sold shares they did not own- They would buy shares after a price dropped and then sell the shares back. Bulls are seen as the opposite of bears as the bear describes the opposite stock market climate. Bullish investors buy stocks in the expectation that stocks will rise, not fall.

General Option Strategies:

Buy Call
Sell Put
Above Market Price

Buy Put
Sell Call

Below Market Price

Investors betting that market prices are going to rise would either buy calls or sell puts. Just the opposite- those betting that market prices are too high and will come down will either buy puts or sell calls.

Options are by far an interesting and confusing investment type. Rather than simply buying a part of a company (stock) or lending money to a company (bonds), options are legal contracts defining possible future transactions involving an underlying security.

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