Thursday, April 06, 2006

Option Trading Basics --- Buy and Sell Option

Buy and Sell Option

To do option trading, you need a special permission from your broker. You have to fill out option trading application forms, and ask your broker to enable the option trading in your existing account or set a special option trading account. Once your account is set up, you can start your trade.

The option trading procedure is like regular stock trading.

A typical buying procedure is as the following:
1. Set the option symbol
Any option has its own symbol just as a stock has. You need find an option that you want to buy, and have the symbol ready. Almost all trading programs provide some functions to make it very easy.

2. Select “Buy/Sell” type
There are four types for “Buy/Sell”: Buy to Open; Buy to Close; Sell to Open; Sell to Close.
At this movement, we only discuss the basic ones. Please select “Buy to Open”.

3. Choose order type
There are two order types usually: Market order or Limit order.
You can select either one. If you choose limit order, you have to input your limit price.

4. Enter the number of contract
Please keep in mind that one contract represents 100 shares of underlying stock.

5. Set the duration or your order
There are two selections at least: Today or Good till Cancelled.

6. Submit order
All programs will show a confirmation page after you submit order. You need make sure to click the “confirm” button (may appear differently in different program)

To sell your option, you need following the same steps. The difference is at step 2 and step 3 as the following:

2. Select “Buy/Sell” type
To sell, you need to select “Sell to Close”.

3. Choose order type
There maybe four order types: Market order, Limit order, Stop order, and Stop limit order.

I will talk about the two stop orders later. For now, you can just pick either Market or Limit order.

The price of an option is always the “whole numbers” such as the multiple of $0.05, $0.10 or even bigger. It depends on the price of its correspondent stock. When you input your limit price, you have to put your price in “whole number” also. For example, you can set your prices as $0.35, or $0.40; but should never set it as $0.37.

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Trading option is almost the same as trading stock. Once you bought an option, you can sell it at any time. You don’t need, and better not, to wait for the expiration date to sell or execute your option.

Let’s talk the same example in my article “Call Option”:

If you bought a call option at strike price $25 and expiration date July, 2006. This option’s price is $1.00 when the stock price at $20.00.

When the price of the stock changed, your option’s value would change accordingly.

If the stock price changed to $21.00, then the option price might increased to $1.20; if the stock price decreased to $19.00, then the option price might down to $0.85.

You don’t need to wait to neither July nor the price reached $25.00. You can cash out your investment anytime you want. You need watch the market carefully and make your own judgment about the trend of that stock, and make the best decision at where and when to sell your option.

But remember, you need sell your option before the expiration date. The option does not like stock, you cannot hold it forever. If it expired, it is worthless.




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