Dawn Pennington

Read This Before You Buy Another Stock

    Tweet This

A simple rule of thumb with options is that when you think a stock, index, Exchange-Traded Fund or commodity is going up, you should purchase a call option. And when you think an individual stock is going down, you should purchase a put.

Many investors stop there with their options trading. When you're trading options as speculation (i.e., to bet that the stock is going to soar or sink), you can either close the trade directly and bank your gains without touching a share of the underlying stock. Or, you can profit a different way -- by using options to buy shares in stocks you want to own!

The 'Short' Cut to Long-Side Profits

You also have the ability to sell options short -- i.e., you can "sell to open" calls and puts. But just like there are risks with shorting stocks, shorting options should be done with great care and as part of your overall trading strategy.

Because it's the most popular way to play the options markets, let's talk about "buying to open" (i.e., initiating a long position in) options and what it means for your overall trading strategy:

* The call gives the buyer the right, but not the obligation, to BUY stock at a specific price, for a prescribed period of time.

* The put gives the buyer the right, but not the obligation, to SELL stock at a specific price, for a prescribed period of time.

You can use these two instruments to play either side of the options market. When you purchase an option, you are reserving the right to:

* Gain a great entry price point for a stock you want to own (in the case of calls)

* Sell stock at a higher cost than the current market value (in the case of puts), or to

* Close (sell) the option position for a profit without touching a single share of stock.

There are several ways to invest with options. Whether we're in a bullish market or a bearish one -- or whether an individual stock or sector is in its own bull or bear market -- we can make money!

How to Add 'Magic' to Your Portfolio

Buying calls is a bullish endeavor, so you make profits when the value of the underlying stock goes up. Here's an example of how you can buy calls as a way of leasing the shares until you're ready to buy.