Dawn Pennington

Read This Before You Buy Another Stock

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Suppose, with Disney (DIS) trading at $29, you purchase the July 27.50 Calls, and those options happen to be trading at $2. That $27.50 is known as the strike price (or exercise price), whereby you can exercise the right those calls give you to buy the underlying stock.

If shares of Disney go up $1, $5, even $10, you would have the right to buy stock at $27.50 during the life of that contract -- in this case, until the third Friday in July, when the option expires.

Or, if you don't wish to purchase stock, you can sell your calls ("sell to close") -- and thus, your right to buy shares at that $27.50 strike price -- to another trader. And with the stock performing well, you can garner substantially more than your original $2 investment.

Buying puts is similar in that you still want to see the value of the options go up, but at the same time, you are forecasting that the price of the underlying stock goes down. Staying with the Disney example, if you think the $29 share price could go lower, you might buy the July 30 Puts.

This would now give you the right to sell stock at that $30 strike price -- or, said simply, you'd have the right to put stock to the put-seller at $30 a share, even if it would trade down to $25. Yes, they would have to pay you nearly $5 per share more than the market value if your estimation turned out to be true!

In this example, in order to exercise your put, you would need to own the underlying shares to be able to "put" them to someone at the agreed-upon strike price of $30 a share.

You don't have to own the underlying shares to buy ("buy to open") puts or calls, so don't let that keep you from buying options and using the incredible leverage they give you to play stocks as they're going up or down!

And again, if you don't want to take advantage of selling the stock, if the value of the options goes up, you can sell your right to make that move by closing (selling) the option position. If your prediction about the direction of the stock and the option were right, you stand to profit either way.

There are so many ways to "win" at the options-trading game, but familiarizing yourself with the powerful tools you have at your fingertips will help you to better plan your strategy and, in turn, anticipate and enjoy the rewards.