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.

Binary Options Explained

Here at Stock Options Explained we’ve gone to some length to describe stock options basics and the fundamentals of trading stock options. Since most investors trade ordinary ‘vanilla’ options on exchanges such as the CBOE, we have limited our discussion to standard stock options strategies such as buying puts and calls, and selling options, both covered calls and puts. I’d like to give a different type of stock options definition in this article.

Binary options, aka FROs (fixed return options), digital options or all-or-nothing options are a slightly different type of investment vehicle about which investors should be aware, as they provide a way to hedge against or purchase leverage on events that do not easily lend themselves to conventional options trading. The mechanics of binary options trading are very similar to options as you may understand them, but it is interesting and instructive to look at some differences in both types of options.

As you might imagine from the use of the term “binary”, a binary options contract either has a payout for the option buyer or nothing at all, depending on whether it is in the money at expiration or not. So far this sounds similar to conventional options, but the fundamental difference between binary options and standard equity options is that the amount that the option buyer, i.e. the person who is long the option, receives at the expiration date is defined and fixed with binaries, whereas with standard equity options trading the value of the option contract will continue to increase as the underlying stock price continues to move further and further beyond the strike price (i.e. higher in the case of call options and lower in the case of put options).

This description should give you a clue as to the type of occurrences that one uses binary options to invest in or hedge against.

Normally binaries are associated to events that either happen or do not happen, such as weather events, or the results of an election. Trade in binary options will frequently be offered based on the results of statistical data such as inflation figures, which may be reported only periodically (even though in reality they are continuously changing, just as a stock price is), and then either pay a fixed amount if they are ‘in the money’, or represent a total loss if they are ‘out of the money’.

The way in which binary options vary from conventional options notwithstanding, they are fundamentally similar in that the seller usually uses them to hedge against an event in which he is already explicitly or implicitly invested, such that selling the binary option serves to protect his existing position. On the other hand, the buyer uses these options to take a leveraged position on the outcome of an event as usual, with the only difference being that he will profit by some known amount should he be correct in taking the position in the first place.

Options Trading Explained-Writing Options

This is the second article of our options trading explained series, in which I will attempt to help you learn options trading strategies as opposed to restricting myself to a generic explanation of stock options. In the earlier post I explained stock options trading in terms of simply going long, or buying, puts and calls as the simplest but most risky of stock options strategies. In this article I’d like to talk about selling or writing options as it opens up a range of possibilities for an investor to improve the overall performance of his portfolio.

When you move beyond thinking of options only as leveraged, risky investment vehicles you begin to understand them as savvy investors and professional traders do, ripe with opportunities for conservative option strategies. There are many ways to use them besides either making multiples of the premium you pay or losing most or all of that premium. I’ll cover options trading examples like writing puts and calls, which affords you hedging options (as it were) that can help you protect existing gains in open stock positions; you could sell options to create an ongoing income from your portfolio without having to sell stock at all; you can even offset losses in stock positions you are not yet prepared to close out, by writing contracts against those long or short positions. All these trading strategies involve simple options selling, and these are just a small fraction of the ways that you can use these incredibly versatile investment tools, once you get stock options explained to you.

Writing Options As A Simple Hedge

Let’s say that you have a nice profit in a stock that you would prefer not to sell yet. Maybe it’s had a run-up recently, and while you are still bullish on the company, your practical side tells you that the stock might very well be due for a pullback.

In addition to the optimism reflected in the stock price, it seems like the options associated with the stock have relatively pricey premiums, with even the out-of-the-money options costing more to buy than they normally might.

For an investor contemplating buying options, this is a risky situation. If you bought, or went long calls here, not only would the upward stock move have to continue, the volatility in the stock has to stay relatively high, or you will see time value decay eat away at the value of your long calls. Let me be clear: Continue reading Options Trading Explained-Writing Options

Finding Your Own Stock Option Picks

Stock Option Picks – Seek Out Good Tools, Not ‘Answers’

Many new investors, having gotten a taste of the potential for profits offered by trading stock options, begin to look for ways to automate the process of picking specific stock options contracts that might have a better than average chance of appreciating before their expiration date. With thousands of stocks having options issued on them and often dozens of combinations of different strike prices and expiration dates, it would be impossible to manually sift through every contract on a daily or even weekly basis.

When it comes to stock option picks however, let’s be clear: think twice before you let your desire for consistent options trading profits compel you to subscribe one of the hundreds of newsletters available on the Internet and elsewhere that promise you barely believable gains. I’m not saying that all of the advice one gets from people selling options picks is bad; I am saying that it is no automatic shortcut to options profits.

On the other hand, when it comes to finding profitable options trades there is no substitute for doing your own research. Listen to everyone, but look for tools that will help you reduce all the market data to trading opportunities that are especially promising, and assume responsibility for your own trades.

There’s little doubt that some investors have found methods to profit consistently with options, but let me ask you a question. If you found a way to reliably pick stock-option winners-I mean really reliably-what would motivate you to sell either your method or a roundup of weekly or daily option picks derived from signals as indicated by your method? Admittedly, selling stock option predictions to hundreds of people each month would represent an attractive income but it would not approach what you could earn for yourself if you had really found a way to make money consistently with options.

In this article, rather than pointing you to specific free stock option picks I’d simply like to remind you what is important and useful if you have made the decision to try to make money trading options for your own portfolio. It’s necessary to distinguish between offers to sell you investment advice on particular options, and offers to purchase or subscribe to tools to help you make your own decisions. Covered call screeners and many other types of option trading software fall into the latter category and are worth learning about.

While these tools imply that you’ll have to do your own work I would suggest that buying tools or access to tools that help you responsibly arrive at your own stock option picks (and hopefully learn from your own mistakes) is more viable than making a leap of faith and paying for dubious advice. There’s a reason for the familiar disclaimer in the fine print of every financial prospectus: “Past performance is not indicative of future results.” It’s there because it’s true! Start your options trading journey by getting stock options explained properly.

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

How A Protective Put Strategy Can Make You Money, And Help You Sleep

The last month or so the stock market has had a run-up of about 10% in terms of the S&P 500; the path wasn’t straight up, but still the rise has been quite impressive. If you are mostly long in your stock portfolio you are feeling some relief compared to the low point just before July 4th, 2010. This might be a good time to explain how a protective put strategy works, as something to consider if you are afraid that stocks may be headed down, at least temporarily, from here.

On this site you have had stock options explained to you in terms of using leverage to aggressively profit from a rise or fall in underlying stock, as well as having call and put options explained as ways to hedge existing positions, with safety as the goal.

You can use puts to protect gains that you may have in your portfolio, or more specifically profit from possible downside moves in stocks or ETF that you might own but do not wish to sell at this time. Reading the financial commentary right now, you’re hearing an awful lot about the possibility of a double dip recession, which would naturally be detrimental to your long stock positions. Buying, or going long, put options is a way to purchase some insurance for your portfolio, and though this ‘protective put’ strategy carries with it some risk, it can be put to good use just like buying insurance, because even if the events you fear do not occur, buying protective puts enable you to sleep better knowing that you have covered yourself, just in case. And, if the underlying stock should fall, the gains you see in the value of your puts will at least partially offset the paper losses you experience in your stock position.

The mechanics using this protective insurance are really quite simple: Continue reading How A Protective Put Strategy Can Make You Money, And Help You Sleep

Hedging With Options

If you have been getting stock options explained to you via this stock options guide, it should be pretty clear by now there are many ways to use options that do not involve increased risk, that in fact serve to reduce overall risk in our portfolio. In a nutshell writing calls and puts usually gives us this ability. In the largest sense, writing options is about hedging, taking the safer side of a transaction in which the person on the other side of the trade is achieving leverage.

As leverage (such as one can achieve by buying calls and puts) is all about making huge gains on a usually smallish amount of money, hedging (e.g. with options) is about achieving rather small percentage gains on (usually) existing positions that are often quite large. If my aim is to explain stock options basics then I must cover both sides of options transactions- the buy (long) side and the sell (short) side.

Hedging can be a better strategy than simply holding a position and being fully exposed to a possible price downturn. Farmers use the commodity markets to ensure that they get a certain price for at least a portion of their crop, guarding against possible lower prices for a not-yet-harvested crop.

We can do this with stock options by selling someone a right to purchase something we own at a higher price, with the stipulation being that if the market never takes the price that high, by a certain date, that we keep the money that we got for selling that right in the first place.

With stock options you can create an income by selling calls with a strike price higher than the current price of the stock, against shares that are already in your portfolio. If you’re not ready to sell your stock in a given company at its current price, but would be happy to sell it at a higher level, simply write a call for each 100 shares of stock you own, with a strike price at which you would be satisfied to sell. In this way, if your shares continued to rise and the price is higher than the strike at expiration, your call will be exercised and you will deliver the shares at the strike price. If your shares are not priced above the strike price at expiration, the calls that you have written will expire worthless and you will simply keep the premium amount that you received for writing them (as well as your shares, of course). Many, many savvy investors with large portfolios make nice rates of return in this way, against stock that they are still bullish on, but could be persuaded to sell at higher levels. The downside of this strategy is that as you are obligated to sell at the strike price, assuming the call is in the money at expiration, you would miss out on any further rise in the price of the stock beyond the strike price.

The concept is exactly the same with puts incidentally, except reversed: for stock that you are short and still bearish on, but interested in hedging, you could write a put contract for every 100 shares that you are short and would like to include in the position, puts with a strike price at which you’d be satisfied in covering your short shares. If at expiration the stock is above the strike price the puts will expire worthless and you will keep the premium, and if this stock price is below the strike price, you’ll simply be forced to cover the applicable shares at the strike price.