Option trading is the process by which investors buy and sell options on shares of underlying stock. The different types of option trading strategies are predicated on calls and puts, which are the two main types of options, and whether these options are being bought or sold. Calls give buyers the option to buy 100 shares of an underlying stock before the option's expiration date, while puts give them the option to sell 100 shares of the underlying stock. For option sellers, most option trading strategies revolve around the manipulation of the strike price, which is the price at which the option becomes profitable for the buyer.
Many investors play the stock market by buying and selling shares of stocks, but they may steer clear of the options market due to their unfamiliarity with it. Trading options can gain significant profits for those investors with timing and stock expertise. All option trading strategies require knowing how options work and their terminology. The premium is the price initially paid by the buyer, while the strike price, set above the current price for call options and below it for puts, is the point at which the option may be exercised, as long as that point comes before the expiration date of the option.
There are no option trading strategies that can work without the investor first knowing as much as possible about the underlying stock. Not only does an investor need to know which way the stock is poised to move, but he also needs to know when the stock will make that move. For those reasons, solid analysis must be done on stocks. This can include analysis of statistical information like price-to-earnings ratios or a more subjective study of where the stock stands in its market sector and how real-world current events may affect its standing.
Buyers of options may take more chances, as their only risk is the initial premium paid for the option. That allows them to try option trading strategies that are based on stocks that have the potential to make a big move in the money. For buyers of call options, that means they should be looking for stocks that are poised to jump in price. On the other hand, buyers of put options should be on the lookout for stocks that are priced much higher than their actual value.
By contrast, sellers of options run the risk of losing much greater amounts if the stock moves heavily in the money for the buyer, while the only gain they can reap is from the premium paid. Since this is the case, the option trading strategies they attempt should focus on mitigating risk. One way they can do this is to manipulate the strike price. A strike price set close to the current price allows the seller to demand a high premium from the buyer, while a strike price set far from the current price will get a smaller premium but protects the seller somewhat from a big price move.