Candlestick Trading Blog

---

Spend any length of time around the stock market and you will hear about options contracts. Some people will say that options contracts are too risky and others will tell you of the fortunes they have made trading options contracts. In either case there are reasons that people trade options contracts; they offer things that stock contracts can’t and in some cases are excellent ways to realize profit while limiting your risk.

When you write an options contract, what are you getting?
Here is the definition of an options contract: An option contract is an agreement between two parties to buy/sell a stock at a fixed price and fixed date in the future. The reason this is called “options” contract is that as time decays, (this is the term for the passage of time) if the deal becomes unfavorable for the buyer he or she can simply let the options contract expire or opt not to fulfill it.

What are the different types of options contracts?
In essence, there are two types of options contracts; Call Options and Put Options. A Call Option is an agreement to buy an asset while a Selling Put is an agreement giving one party the right to sell the asset.

Example of a Call Option
Let’s use an example for some option trading education. Fred buys a Call option contract from John. The options contract says that Fred will buy 100 shares of MEW Industries from John on September 8th at a strike price of $15; MEW Industries is currently trading at $20. At this point Fred has no obligation; he has only purchased the right to buy the stock if he desires. If the stock is at $20 on September 8th, Fred can buy from John at $15 per share, also known as the strike price. John can then keep the shares or make an instantaneous profit buy selling them for their current price of $20.

If the shares are trading for $10 instead of something above $15, John wouldn’t be interested since he can buy them for less investing in the stock market. In this case he will simply let the options contract expire and Fred gets to keep the premium that John paid for the option contract. One thing to note in this example is that John won’t actually be buying his options contract directly from Fred but from a broker instead; the end result is the same but the broker facilitates joining buyers and sellers.

Example of a Put Option
Here’s a second example. John sells a Put option contract to Fred. The options contract says that John will sell 100 shares of MEW Industries to Fred on September 8th at a strike price of $20; John purchased his MEW Industries shares for $15. There is a $0.25 per share premium on the contract, so John has realized a $25 profit already. If the price is not at $20 on the 8th, the contract expires and John keeps the $25 premium. If the price is $22 on the 8th, John will sell the shares to Fred, keep the $25 premium along with the $700 ($7 per share for 100 shares) he is a successful trader, making a total of $725 on the deal.

Conclusion
Options contracts can be beneficial way to accumulate income in the stock market. Stock option trading strategies allow the trader to realize profits, in many cases, with limited risks. When using solid technical analysis and a strong trading system like Japanese Candlesticks, options contracts provide another good method for playing the stock market game.