Options trading is a way for traders to control hundreds of shares of a stock with little money invested. You can make a profit if the stock’s price is going up or if the price is going down, as long as you buy the correct options.

Option Trading Basics

When you buy one option, you will control 100 shares of a stock for a small amount of money. If you were interested in controlling 100 shares of a stock that cost $90 per share, it would cost you $9,000. But options cost much less. For example, you might buy an option for $2.00, which would allow you to control 100 shares for $200.

If you plan to trade options, there are various methods of analyzing them that you should be familiar with, known as the Greeks, because they are Greek letters. For example, beta is how much a single stock moves relative to the overall stock market.

Buying Call and Put Options

Buying call and put options are basic options trading and what most beginners start with. When you buy a call option, you have the right to buy the stock any time before expiration. But most people let the option expire and hopefully collect a profit.

You will buy a call option when you expect the stock to rise in price by a certain amount before the expiration date. If the stock price doesn’t increase enough by the expiration date, it will expire worthlessly.

Buying put options is the same as buying call options, except you will buy put options if you believe the stock price will fall before or by the expiration date. When you buy call or put options, the most money you can lose is what you paid for the options, and there is no limit to the profits.

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To profit from buying call or put options, you have to be correct in the direction of the price movement, the amount of the price movement, and the timing of the price movement.

Buying Options on IPOs

An IPO (initial public offering) is when a company decides to go public and sell stock to the public for the first time. IPOs are usually highly sought after because they are new companies with a lot of market interest and can soar once publicly traded. It can be hard to get your hands on IPO shares before the day it goes public.

Sometimes these IPOs can take off in price for the first few days or weeks and then fall to a more reasonable price. Buying options is one way to capture these rapid price movements when a company issues new stocks on the market. Before buying options on an IPO, you need to understand IPOs.

Money Morning Chief Investment Strategist Shah Gilani says to pay attention to the expected valuation. “If the stock opens at the very top of its valuation range, or above it, then it might be a good idea to hold back and wait for shares to settle down before buying. Same thing if the stock opens near or below its expected valuation. Negative sentiment could push it down ever further, giving you a chance to buy low.”

When you trade options, you control hundreds of shares for less money than what the shares would cost. The only risk is what the options cost you. Buying options on IPOs is another way to profit from companies that have issued new stocks on the market.

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