Stock options are a form of leverage for advanced investors to boost returns of his or her stock portfolio. In the most basic definition, an option is a contract, the option to buy or sell a certain stock at a predetermined price.
Options are leverage; using leverage either increases investment returns or burns investor’s portfolios. Like options, guns are a form of leverage, if you’re hitting your target great–but you can also blow your foot off.
There are many reasons an investor may use stock options, hedging, lock-in gains, or as speculation. By hedging an investor reduces the risk of losing money during a price decline. Likewise, an investor would use stock options to reduce the risk of losing gains from selling options. And these advanced investors may wish to speculate on a stock price movement, therefore might use stock options to play the market.
Vocabulary of an Options Trader
We’ve already covered some of the vocabulary of options trading, but now we’ll dive in deeper to explain the difference between call and put options, then explain a few simple strategies option traders use to boost gains.
A call option is the right to buy shares at a certain price. Conversely, a put option is the right to sell shares at a certain price. Simply meaning, a call option means you expect the price of shares to rise. Whereas, buying a put option means you expect the price of shares to decline.
The strike price is know as the price which shares may be purchased or sold. This means, if you bought an option with a strike price of $50, you could buy or sell the shares of the option at $50.
But why would anyone want the option to buy or sell at $50? Well what if you had the option to buy the shares at $50, then the price rose to $51, you would’ve made $1 per share. Similarly, what if you had the option to sell the shares at $50 and the price fell to $49, then you could’ve sold the shares at $50 then bought the shares again at$49–a profit of $1 per share.
In both put and call options the purchaser has the option to exercise her purchase, while the option seller has the obligation to respond to the buyers request.
So, How Does This Help My Silver Portfolio?
Well, you know that the FOMC (Federal Open Market Committee) is getting to lower the target interest rate, thus causing a further decline of the U.S. Dollar and increases the rise of inflation. So, you buy a call option now, and when the FOMC lowers rates you get to profit from the price increase of silver mining companies.
Or the opposite situation where you think the FOMC is getting ready to increase the target rate, so you buy put options and profit from the fall in prices of silver mining companies.
Puts, Calls, and Conclusions
Carefully consider using options to invest because of the leveraged nature of options. Options may provide opportunities to increase your portfolio, but options can also burn through your portfolio at break-neck speed.
Also consulting your tax and investment advisers will prove to be a prudent move. Options have different tax effects your tax situation. Before investing in options, it is important to thoroughly understand the potential risks and benefits–options could either help or hurt your portfolio.