Some basic Option Strategies

When you learn about options-really learn- you'll understand why they have become so popular. Don't let the word derivative scare you. Read on and find out whey options are the way to go. Most importantly, options provide investors with the flexibility to choose from a wide range of strategies. In this short article, we'll discuss some of the more basic and easy to understand ways to employ stock options.

Long Call

The most basic and easiest to understand is the long call. This is when an option is purchased with the idea that within a certain period of time the value of the option will increase and profits can be made with a much smaller investment than would be needed to purchase the underlying stock. For example, if the underlying stock is currently trading at $30 and you expect the stock to go up to $40, a trader can purchase long call options with a strike price of $ 31 that would expire in some future month. If the option moves past the strike price ($31) the stock option owner can either exercise the option and acquire the underlying stock or hold the option and take advantage of the option premium appreciation.

Long Put

Traders who believe that the future price of a stock may go down in value within a certain period of time can buy the right to sell the stock at a certain price. As in all options, the option holder has the right to sell the stock but not the obligation.

If the market price goes down as anticipated within the time period of the option the premium price will increase and the trader can profit from the difference of the purchase premium and the current premium price. If the price does not increase, the trader can let the contract expire or sell it to someone else.

Short Call ( aka: Naked call)

When a trader sells (writes) an option, he can either own the underlying stock- which case it is called "covered" writing and or in the case of a "naked" writer, an option is written without actually owning the stock. In the case of writing a naked call, if the market price of the underlying stock decreases, the short call writer will profit by the amount of premium change. If the price of the under lying stock increases, above the strike price of the option contract then the short call will suffer a loss. The short call writer is betting that the stock will not go up. If the short call is exercised then the writer is obligated to buy the underlying stock and honor the option contract specifications. This is perhaps one of the riskiest strategies because of the potential of having to purchase the stock in the open market and then transfer the stock to the short call option holder.

Short Put

If a trader believes that the future price of a stock will increase, they can sell (write) the right to sell the stock at a certain price. If the stock price goes up, the short put position makes a profit on the premium. Conversely, if the price goes down below the strike price, the put writer (same thing as short put) loses money.

To summarize, to be long is to purchase a call or a put. To be short is to sell (or write) a call of put believing that the price will not move in the direction of the call or put. Shorting is a contrarian strategy with a high probability of being correct if going against the prevailing trend as 70% to 80% of stocks move in sync with the strong underlying market trend.