This is actually a big subject itself. Trying to cover it in this article is practically impossible. However, in order to provide you with a glimpse of how to use options for trading purpose, a snapshot of basic working mechanism of how options work can be useful to get you started.

While you may not be aware, you have used one form of options one way or other. Therefore, to say that you don’t understand how options work is really unlikely. Take the case of a movie ticket. When you buy a movie ticket to watch a movie, you have actually bought an option to watch it. Assuming you’ve bought the ticket one day in advance for a next day 7 PM show, you’ve got yourself an option to watch it by that time but are absolutely not obliged to watch it. If you change your mind hours later because your long aspired date suddenly come on to you at 7 PM, you may want to forget about the movie. The maximum loss you incurred is the price you pay for the movie ticket, no other obligation whatsoever. Nevertheless, the movie theater operator owed you the right to watch the movie by 7 PM the following day. Otherwise, a full refund plus apology are normally expected. Hence, the seller of the movie ticket is obligated and is expected to deliver the promise of screening the movie by 7 PM the following day.

Other forms of options that are most frequently used by ordinary people are insurance, any form of written order contract such as a letter of undertaking for a house purchase, a guarantee given by a manufacturer of a product, and many others.

For now, it is a good idea to look at the definition of an option:

An option is a right, but not an obligation, to buy or sell an underlying security or instrument at a specified price on or before a predetermined date.

An example will help illustrate this concept clearly. Suppose you intend to buy a house for $100,000 and the owner is willing to sell it at this same price. The agreed price is the strike price (also called exercise price). A letter of intent would normally be drafted out to spell out the terms and conditions of this purchase which should also include a date for the transaction to take place with a small deposit requested.

In the above example,

1. The letter of intent is the option
2. The house is the underlying security (asset)
3. The $100,000 is the specified price (also known as strike price/exercise price).
4. The date to be transacted is predetermined
5. The small deposit is the premium (option price)

Types of Options:

1. Call option – A CALL is an option to BUY.
2. Put option – A PUT is an option to SELL.

A CALL option is the right, not an obligation, to BUY an asset at a fixed price on or before the predetermined date. You buy call option when you expect the underlying asset to appreciate in price.

A PUT option is the right, not an obligation, to SELL an asset at a fixed price on or before the predetermined date. You buy put option when you expect the underlying asset to depreciate in price.

(For purpose of simplicity, I will not discuss SELLING call or put options in this article. This is a subject that a more experienced trader will definitely want to consider but will find it confusing in the beginning.)

The purchase of a CALL or PUT option outright is known as straight call or straight put. Generally, options are more volatile than their underlying instrument. Hence they give traders ‘more bang for their buck’ because for a small amount of money the traders can control a large amount of stock. Clearly, this can leads to danger. However, as you shall find out in the seminar, this leveraged power can also lead to more safety and security for your investment. Option is like a high-speed highway to investors as opposed to countryside road. Reckless speeding can kill, just as indiscriminate speculation on option. If we follow rules and give away some of those leveraged power, we can still move ahead much faster than we normally would and yet find great safety and protection.

To summarize, options give the investor added flexibility, potentially much greater gains for a given movement of the underlying asset, and yet offer good protection against risk. This is the essence of trading options to success.

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