Stock market investors frequently use stock options as an investment vehicle.
Since they derive their value from a stock's valuation, they are derivatives.
An option that has been sold becomes a contract involving the seller, also called the writer, and the buyer.
The buyer, if he chooses, may either buy the stock from, or sell the stock to the seller.
Here are some important facts about stock options and option trading strategies.
Security trading strategies are based on estimates of the future trend of a stock's price.
Investors use this information to determine what kind of buying or selling activity is appropriate.
Bulls think the stock will go up and take long positions.
Bears think it will go the other way and thus tend to favor short positions.
A call option gives the buyer the ability to buy the specified stock from the seller at an agreed price called the strike price.
The selling price of the call is referred to as its premium.
The buyer can do this at any time up to the expiration date.
A bull would tend to buy calls, at least for the stocks they are bullish on.
In their world view, there should be a time while the call is still active when the stock price is higher than the strike price.
Thus by exercising the call they get a break on the purchase price.
Bears may also use calls, but they would sell them rather than buying them.
If the stock declines in value, the call will not be used, but the seller gets to keep the premium.
It is possible to sell a call on a stock that one does not own, creating a naked call.
The danger with this is that the market price could go up by any amount.
If it does, the call seller will have to cover that rise somehow.
A put option is the mirror image of a call.
The buyer can sell the stock covered to the put seller at the put price while the put has not expired.
The strategies would call for bulls to be selling them and bears to be buying them.
These strategies are just the beginning.
There are variations and issues that are not discussed here.
The trader always tries to buy low and sell high.
Translated to options, bulls expect increasing prices and bears expect decreasing prices.
The hard part is estimating the future path of a stock's market price.
Guessing this should lead to selecting one of several appropriate option trading strategies.