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Make Money Trading Options
Last week we wrote about writing stock options for income. This is one way to make money trading options. A common example is to sell a covered call option on a stock that is unlikely to go up in price. The other way to make money trading options is to buy calls or puts on stocks whose price you believe will change before expiration of the options contract. This raises the subject of just what are calls and puts and how do you make money trading options in this manner.
Over the long term those who sell, or write, options contracts make more money than those who purchase them. The problem for options sellers is that they take on a risk in return for a contract premium. At times this risk can be substantial so that in general one needs a lot of capital and a lot of expertise to make money continually selling options and not be wiped out by an occasional disastrous trade. Options sellers limit themselves to trades in which they believe that the price of the underlying stock will not change or at least not change in the direction that would lead to a loss. A common approach of individuals who own very stable stocks is to sell call options on the stock and gain extra income on top of their quarterly dividend payments. The only risk is that if the stock does go up sufficiently they will lose out on the gain but on the other hand there is never any risk of losing money.
Those traders buying options expect to make money trading options when they believe that the price of the underlying stock will change substantially within the term of the options contract. The direction of the anticipated change is what determines whether the trader buys call options or put options.
Call Options and Put Options
With American style stock options, a trader buys a call on a stock and he pays a premium for the right to purchase the stock for a set price at any time until the contract expires.