How To Learn The Stock Market

It’s a rite of passage, learning how to manage your own money when you get your first “real” job. From every direction people are offering suggestions as to investments into which you can put any extra money that you may have at the end of the month.

In all likelihood you’re thinking to yourself “what money?” But this simply confirms how careful you have to be in deciding how to invest, and underscores how vital it is to do the work of teaching yourself how to learn the stock market, about bonds and mutual funds, and even more sophisticated investments such as stock options.

Here at stock options explained we get questions quite frequently that do not specifically pertain to options, but rather from people trying to understand the stock market, which is after all the basis for options. In fact you can be sure if you have not yet learned how the stock market works, even stock options basics and certainly all options trading strategies will forever bewilder you.

Three tips for learning about the stock market

1) Learn from people with actual experience in the market. Perhaps you have an older relative or friend who is quite savvy financially, who seems to have a good handle on most investments. Don’t be afraid to ask detailed questions of them, because in addition to knowing the rules of the game as it were, you can trust them and be quite sure that they’re not trying to sell you on the particular investment.

2) Bookmark and frequently visit websites like Motley Fool and MarketWatch, as they give the opinions of a broad range of market analysts and vary their approach to cater to seasoned investors as well as neophytes. Sites like these and many others also function as educational portals, and if you’re interested in learning the stock market they’re a great place to start for this reason. Another good thing about many financial sites nowadays is that they incorporate a forum where readers of the site can participate in financial discussions and ask questions. Everyone was once a newbie investor, it’s nothing to be ashamed of, and you have a wealth of information in the form of other people that you can meet on financial forums who will be more than willing to help you learn the stock market.

3) Probably the very best piece of advice I can give for anyone who’s interested in becoming proficient in investing in stocks is to paper trade. If you’re not familiar with paper trading, you should know that most online brokers offer you a practice account online with an amount of virtual money that you can use to trade stocks, options and other investment vehicles. Your broker will keep track of how well you do on each trade and you’ll be able to keep very close tabs on just how well your hunches regarding stocks that you trade are translating into profits, or losses.

If you are wondering how to learn the stock market do yourself a favor and remember this tip: take your time, paper trade and find some good trading software to help you, and do not make the mistake of thinking that since you are understanding stock market basics you will easily be able to turn a profit in investing in stocks, or stock options for that matter. There is a huge difference between learning how the stock market works and applying your new-found knowledge to consistently make money in the market.

Explain Option Trading In Terms Of A Risk Continuum

Don’t let the word ‘continuum’ make you click away; my point is that most investing neophytes think of stock options as risky investments and it’s just not the whole story. While it’s true that going long with calls or puts means that you are risking most or all of your investment funds in that particular position, it might be helpful to explain option trading in terms of a risk continuum, because the fact is that there are conservative option strategies as well as risky ones that traders can employ.

The idea of using just a little bit of money to control 100 shares of stock per contract that one buys, thereby benefiting from potential moves in the stock that one anticipates, is attractive for some traders or investors (and lots of speculators!). Certainly leverage has a place in some portfolios, to be taken on with only a small percentage of one’s investment capital. The stories one hears of traders doubling or tripling their money in a week or less certainly are accurate, though as you might expect the likelihood of this happening is quite low for most people, certainly much less than 50%. Having said that, one can still use a strategy of buying puts and calls when one has a hunch that a move might occur in the short-term. While long-term options, called LEAPS, can be employed successfully if you have a longer time horizon, buying options is usually done with an eye toward a short-term gain because of the time decay that premiums suffer as a contract gets closer to its expiration date.

So let’s look at the other side of this continuum. Many people with larger portfolios use writing, or selling, puts and calls as a way of augmenting their portfolio such that they actually reduce their overall risk exposure. If you think of options only as risky investment vehicles then that might surprise you-here’s how these conservative option trading strategies work: Continue reading Explain Option Trading In Terms Of A Risk Continuum

SFAS 123 Guide

Employee stock options are non-standardized call options that aren’t traded on options exchanges, but rather exist as a private contract between a company and its employees (or other parties such as lawyers, consultants, vendors, etc. as a form of compensation). Accounting for stock options is often in the news relative to executive or employee stock option compensation, so I am including a brief explanation of FAS 123 on this site so that if nothing else people can be directed to the authority website on this subject.

Briefly, the purpose of the SFAS 123R ruling, as issued by FASB (Financial Accounting Standards Board, the authority for financial accounting standards in the USA) is to define a fair value based method of accounting for stock options issued to employees and others by corporations as part stock compensation plans. Option “fair value” can be estimated by option pricing models like Black-Scholes, Black-Scholes-Merton model, lattice models or by other methodologies. Corporations then expense the option compensation an asset over the vesting period of the option.

Under SFAS 123 standards it is also acceptable for a company to measure or quantify compensation cost for their stock option plans using an intrinsic value based method of accounting, as covered by APB Opinion No. 25, Accounting for Stock Issued to Employees. See this FASB pdf file for detailed information, as well as a lucid SFAS 123 summary. Also, here is an excellent site that can help companies value employee stock option with an easy to use calculator using the lattice model with variable inputs. I hope this has been helpful; I felt that as you get stock options explained to you, confusion might be avoided if I explicitly cover the difference between exchange-traded options and options in other familiar contexts, such as employee stock options.