Something you should keep in mind when options trading, is that there is always another trader on the other side of the trade, doing the exact opposite to what you are doing.

So when we buy (or take) an option, someone else has sold (or written) that option. We can choose to play either role in    any trade and as an options writer, instead of paying the premium for the option contract, we receive it! When you        write options, there are two ways to expose yourself to risk.

You can write Covered and Naked.

Your choice really depends on your comfort level with the risk associated with each and what results you are trying to achieve.

When you write Covered Calls, it means you actually own the stock you are writing options over and are looking to make some additional income. Even if the option holder exercised their right and you had to sell your shares, you would still keep the premium you received.

Writing Naked options means you are promising to buy, or sell shares you do not own.

An example would be if you wrote a naked put option. You are obligated to buy someones shares from them at a price higher than market value if you get exercised.

You are then stuck with shares you paid too much for, or you can sell them straight away at a lower price. Either way results in a loss.

If you decide to write naked puts, it should only ever be on shares you really want to own anyway (and can afford). You would benefit from doing so by collecting premium while you wait for the stock price to fall lower, resulting in more of a ‘wholesale’ purchase price.

The danger of course is in trying to pick the bottom, it may drop drastically more, resulting in a bigger loss overall.

The opposite applies if you wrote a naked call. If the price rose above your strike price, you would be obligated to buy the shares at market value and sell them to the option holder at a lower price.

As an options writer you need to be extremely cautious if you decide to write naked.

There are advanced options strategies however, that allow you to write options to collect premium with insurance to minimise your risk. This means you are almost covered, and can make money out of nothing.

To your success

Jules Dawson

• The right (but not the obligation) to sell   
• A fixed number of shares at a fixed price (strike price) 
• On or before a fixed date (expiry date)

You would buy put options when the market is falling, as they give you the right to sell shares.

The strike price is a fixed, pre determined price at which you can sell the shares if you choose to exercise your right to do so.

As the buyer of an option, you can exercise your right at any time before the set expiry date.

Australian stock options expire on the last Thursday of every month. *This may vary over public holiday periods.

Each stock has set strike prices for trading. Depending on where the strike price is in relation to the current share price, influences the amount you pay, or the premium.

So how do you profit from Put Options?

The value of a put option increases as the share price falls. As an options trader, you would buy put options in a falling market, and onsell them for a profit. You can do this anytime up until that option’s expiry date.

Another clever use of options is for insurance over shares you own. Just as you would insure your house or car, by insuring your shares (hedging), you are protecting your investment should the market fall or suddenly crash.

For example, lets say you paid $ 20 for a share and you bought a put option with the same strike price. If the share price suddenly fell to $ 12 you could exercise your right to sell those shares for $ 20 without incurring any losses.

To your success

Jules Dawson

When you purchase a CALL option, you have……

• The right (but not the obligation) to buy      

• A fixed number of shares at a set price (strike price)   

• On or before a fixed date (expiry date)

You would purchase call options when the market goes up, as they give you the right to buy shares.

The strike price is a fixed, pre determined price at which you can purchase the shares if you choose to exercise your right to buy.

As the buyer of an option, you can exercise your right at any time before the expiry date of that option.

Australian stock options expire on the last Thursday of every month. *This may vary over public holiday periods.

Each stock has set strike prices for trading. Depending on where the strike price is in relation to the current share price, influences the amount you pay, or the premium.

So how do you profit from call options?

The value of a call option increases as the share price rises. In the business of options trading, your objective is to onsell the call option before expiry for a profit. This is called short term trading and allows you to profit from a much smaller amount of money in a shorter period of time.

If you are still holding a call option on expiry day you may choose to exercise your right to buy those shares, however you would only do this if the current share price was above the option strike price. This would then allow you to sell those shares afterwards at a profit.

To your success

Jules Dawson

Did you get the same reactions that I got when I first told my family?‘It’s too risky’, and ‘That’s a sure way to lose money, better leave that to the professionals!

What most people don’t realise is when you buy a car you are guaranteed to make a loss as it will depreciate in value, but nobody seems to react the same way when you show themyour new wheels!

Honestly,for me taking the ‘risk’ and learning to trade was THE best move I ever made in my life. Today, I earn a very healthy income through several investment strategies (one of them is trading stock options for cash flow) and I ‘work’ only a few hours a week.

Now every investor has their own take on which is the best vehicle to use when putting money into the market. These days there are so many trading vehicles available, it can be quite confusing to the beginner.

So if you were to ask me “Is stock trading better than trading stock options?” I can only answer from my personal experience.

I trade stock options for income and I invest in stocks for capital growth. Notice I said invest not trade? There is a big difference. When you invest in something, you are purchasing to hold onto it, eventually hoping to profit. When you trade something, you are purchasing to onsell it for a profit.

Investing in shares for capital growth has given me the ability to diversify my investments, not just in the sharemarket, but in real estate. But I will go into that in more detail at a later date. For now though, if you are looking to replace your income or just earn a little extra money, options trading can be a powerful money making tool. Stock Options offer you leverage -a smaller amount of money used over a shorter period of time equates to higher returns!Stock Trading can also present healthy profits, as well as bonuses like dividend payments while you hold, however, you need to have much more money to be able to purchase the stocks (or shares) in the first place, and you would be expecting the share price to increase (and quite rapidly) in order to sell at a profit.

Blue Chips are established performers, or the tried and tested favourites if you like. These companies offer opportunities for profit with more peace of mind than speculative stocks, but owning them can be expensive. Owning an option over the same shares costs a fraction of the price.

For example, XYZ share might cost $ 15.00 to own, whereas $1.50 might buy you an XYZ option that gives you control over a parcel of those shares.

Confused? I’ll try and make it a little more simple.

Stock Options give you:

The right (but not the obligation) to buy or sell a fixed number of shares at a set price (strike price) on or before a fixed date (expiry date)

Call options are contracts to buy shares.

Put options are contracts to sell shares.

The value of a Call Option increases when the share price increases.

The value of a Put Option increases when the share price goes down!

So when options trading we would buy puts when the market is falling, and sell them for a profit!
And we would buy calls when the market is increasing and sell them for a profit.

On the U.S market, one option contract typically relates to a parcel of 100 shares and 1,000 shares on the Australian market.

So in the previous example, on the Australian market, to trade the stock would have cost us $15,000 to buy the shares before we could sell them for a profit, whereas an option contract over the same shares would have cost us $1,500.When you trade stock options your maximium potential loss is limited to the amount you initially pay for the option contract. Doesn’t a risk of  $ 15,000 sound more frightening than $ 1,500?

I use options trading to make a steady income, not an overnight million, so my risk is minimised and my profits are retained. With the strategies I use the full option price is never my maximum loss, it is much much less.

To your success

Jules Dawson

Options Trading for Beginners