Stock market trading opens up the opportunity to make an enormous amount of profit, if one is knowledgeable enough and exercises sound judgment.
Stocks and bonds are the typical types of investments for beginners and those who are more conservative.
Individuals who want to take a little more risk may elect to enter into options contracts.
If they choose to do so, they should use one of the well-known option trading strategies.
There are several reasons to use option trading strategies and they differ depending on the market conditions and whether the person is buying or selling.
Generally, they are used by purchasers to limit their losses to the premium paid if the option is undervalued and has increasing volatility.
Sellers use them to limit their losses in situations of large credit.
When the market is neutral, employing certain option trading strategies can provide the investor with a sure way to make a profit.
Investors who are just starting out usually employ a covered calls strategy because it is more conservative.
It involves writing a trading contract to buy while owning shares of the stock.
In stock option trading, one options contract gives you control over 100 shares of stock.
These shares are usually held in the same brokerage account from which the call contract is written.
In essence, the holdings serve as collateral for the obligation inherent in writing the call contract.
As investors gain more experience in options trading, the naked calls strategy may be something they utilize.
This occurs when the investor sells call options on the market without having any ownership of the stocks.
It is also referred to as an uncovered call or short call strategy.
There is more risk inherent in this strategy because the potential for profit is limited, but the potential for loss is unlimited if the stock price increases above the exercise price for the options being sold.
It is recommended that this strategy be undertaken only by experienced investors who are confident that the stock price will stay flat or fall.
Margin, or collateral deposit, requirements are usually very high for this strategy due the possibility of open-ended losses.
However, if all goes well, the investor may receive income from premiums without having to make a large initial capital investment.
Covered calls and naked calls are just two trading strategies used by investors.
Other common techniques involve call options and earnings strategies and each is appropriate in different situations.
Those who have little experience with options trading contracts should gain a basic understanding of this type of investment and educate themselves regarding the different option trading strategies prior to entering into an options contract.