How to make money in the stock market - By: alexchong

There are abundant of money in the stock market. However, not everybody can get the money out from there. Some people can gain a lot from the stock market but some has lost a lot of money there. It is very indecisive. Sometime at that moment, you loss money but after a few days, you may earn a profit and sometime is reverse. So, how should we do to get the money out from the stock market? Usually, there are two ways to get the money out from the stock market; that are investing and trading. The difference between trading and investing is trading involves buying and selling stocks, futures or options within a short period of time; whereas investing is buying stocks, futures or options and hold it for quite a long time, usually one year or more before selling it.

What is the difference between stocks, futures and options? What we know is that options is much cheaper than the stocks and futures, usually is tenfold lesser than the stocks price. So, if you have an amount of money that enough for you to buy 100 units stock, you can use that amount of money to buy 1000 units option. And the return of investment is almost the same between stocks and options. Therefore, you will earn around tenfold if you buy options rather than stocks or futures. However, the disadvantage is that if you lose on that trade, you will lose almost tenfold also. When we trade options, the amount of money that we can profit and lose is almost same as if we trade stocks. However, we need a lot of money to buy stocks compared to buy options. This causes the percentage of the profit and loss for buying options is much higher than stocks. The example is like when you buy $10 for one unit of stocks and $1 for one unit of options. When the stock price drops for $0.10, the percent drop for buying stock is 1% but for buying option, the percent loss is 10%. That’s why the percentage of the profit and loss for buying option is huge compared to buying stock even though the stocksprice fluctuates in a small amount.

Due to the high profit and loss when buying options, trading or investing option is just like gambling. It is quite normal that the return of investment is more than 100%. But it is also quite normal that you could lose all your money in the investment or trading. In order that you can earn more than lose, you need to know some basic option trading strategies and technical analysis skill. Option is different from the stock. Option has time value; whereas, stock does not have time value. The value of one stock will not depreciate due to the passage of the time. It is only affected by the supply and demand and also the company performance. However, option value will depreciate when the time has passed. When the time reaches to the option expiration date, there is no more time value for that option. That’s why, you need to use strategy to trade option, in order that you can minimize the loss and maximize the profit.

The very basic two option trading strategies are bullish call spread and bearish put spread. Bullish call spread is used when the stock price is anticipated to rise in the coming months; while, bearish put spread is used when the stock price is anticipated to drop in the coming months. Steps that are involved in this strategy are buying in the money option and selling out of the money option. In the money option is the option that has time value and intrinsic value; whereas, out of the money option only has time value. When the stock price moves to the positive side (generated money side), in the money option will generate profit and the out of the money option will cause loss. However, the minus of the profit and the loss is the net profit that has generated from this strategy. When the stock price moves over the out of the money strike price, the profit will become maximized. Continuously moving of the stock price to the positive side will not generate any profit. In this situation, we will close both positions to take the profit out from the market.

If the stock price moves to negative side (opposite side that cause loss), in the money option’s value will depreciate and the out of the money option will generate profit. However, the profit, which is generated from the out of the money, is limited to the price that you have sold. The subtraction between out of the money’s profit and in the money’s loss is a negative value. This is because the profit that is generated from the out of the money option is less than the loss that is caused by in the money option. Out of the money option’s profit is limited in this strategy and in the money option’s loss is unlimited. If the stock price continuously moves to the negative side, you may lose all of your capital. So, what is the difference from buying naked option and buying option using spread strategy? The difference is that you may lose more money if you buy naked option and lose less money if you buy spread. This is because you do not generate any profit when you just buy naked options; whereas, profit is generated from the out of the money option if the stock price moves to the negative side. The disadvantage of the spread is that the commission, which is charged by the broker firm, is double compared to the naked option. This is because, naked option only involves one position; whereas, spread involves two positions. Each position will be charged with commission separately.

Besides, the purpose of selling out of the money option in the spread strategy is to minimize the loss of the time value of the in the money option. Actually, both in and out the money option’s time value would depreciate when the time has passed. Because we do not own the out of the money option; therefore, we can keep the money that we have received from selling that option. When the time value of this out of the money option has depreciated, we used lower price to buy back the option. So, we sell at high price and buy back at low price; therefore, we earn money. The money that we have earned usually is enough to cover the loss of the time value from the in the money option. However, you still lose the intrinsic value of option if the stock price moves to the negative direction.

So, bullish call and bearish put spreads are two of the very basic option trading strategies. However, it is not guaranteed 100 % win from the stock market. You still need to learn to predict the stock price direction accurately using technical, fundamental and news analysis.

About the Author

Alexander Chong - Author of “Workable Option Trading Strategies” http://www.makemoneystocks.com/

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