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The common definition of option trading is the making of a two-party contract where one retains the right to purchase or sell a fixed amount of the underlying security at a set price and within a fixed period of time, although he or she is not obligated to do so. The evident opportunities for profit have caused an ever-increasing number of speculators to enter this field.

Option trading is something that investors can use so that they can keep their portfolio of stocks safe against sudden downward pressure. This is a cautious strategy where puts are purchased to act as a hedge. Investors then buy the right to sell stock which is already owned at a certain price no matter what the current market is doing. Suppose the price of the underlying stock keeps rising instead of falling, the strategy will then have a limit to the portfolio’s upside chances of reducing it by the cost made with the purchase of the puts.

Selling calls when you own the underlying stock is one more conservative option strategy. It’s also known as covered call writing. Many investors use this strategy in order to create further income on stocks they already own. Additionally, covered call writing offers limited downside protection in the case of a market downturn.

If the stocks drop just moderately, a covered call writer may cushion the blow of the decline since she or he is entitled to a premium for selling calls. But if stock prices drop dramatically, the investors will still lose money as the premium received for calls won’t offset mounting losses in underlying stocks.

Investors with a high level of risk tolerance may wish to leverage relatively moderate sums of money. Buying options is associated with rights but not obligations. Traders may purchase calls with the expectation that they will be able to sell these later at a profit- if the price of the underlying security goes up. Speculators buying call options or selling put options, hope to profit from rising prices.

Traders can buy puts hoping to later make a profit from selling them later, after the underlying inspection drops in price. For the ones who speculate buying put options or selling call options eventually hope to gain profit from the falling prices. Due to the fact that speculators may possibly never own the underlying equity, there is a risk they can lose large amounts. If a long option expires worthless, the options buyers will not lose more than the amount they paid for their options plus commission.

Conversely, speculators who disposed of options could forfeit much more than the premium they earned for liquidating them. If you find all the terminology confusing regarding option trading, do a little research with the help of the Options Dictionary as a part of your stock option education.

Option trading are generally defined as a contract between two parties in which one party has the right but not the obligation to buy or sell a specified amount of an underlying security at a specified price within a specified time. The great leverage through options attracts more and more speculators. A very conservative option strategy is to sell calls while you own the underlying stock. If you find all the terminology confusing regarding options trading, do a little research with the help of the Options Dictionary as a part of your stock option education.

- David Baxwell