Only being aware of what you think about the option is not enough, it is prudent to know what others think about the option also. You should talk to people who trade in stock options, read books on that topic and do everything possible to keep your self abreast of all that is related to stock options. Doing this should fairly give you an idea of trading in stock option, to get some practical experience; you could also try “trading on paper”

There is no ground rule to choose the winner stock, you have to do an extensive research on your prospective company and then decide whether it is worth while to invest.

The basic things that you ought to check in the company are; 1. Company’s track record; it is important that you look at the performance of the company in the past few years. 2. Check the price of its stock and its volatility; more often than not after a technical analysis of the stock price you will be able to speculate its price movement. 3. Keep an eye on any current news such as stock split, mergers or accusations or any other investment that the company may be going in to.

In option trading, you can make money either ways. If you expect the stock price to rise, you should buy a call option. A call option is a right that the option holder enjoys, to buy the stocks of the specified company at a specified price. This specified price is called the exercise price. Now, if you buy a call option you will gain if the stock price rises, because you have the right to buy the stock at the exercise price at the expiration of the option. This way you can acquire the stock at a lower cost and sell it in the open market at the market price, there by booking profit. You can also sell the call option if you are expecting the stock price to fall. In this case there is one catch; you are exposed to unlimited loss and limited gain. Your gain is the premium amount that will be paid to you by the buyer of the option, on the other hand if the stock prices rises instead of falling then you will have to buy the stock at a higher price from the market and sell it at the lower exercise price, to the buyer of the call option. This is a naked or an uncovered call option. You can hedge yourself by purchasing a call option with a lower exercise price and a longer maturity. Similarly when you buy a put you are expecting the price to fall and when you sell a put you are expecting the prices to rise.

If you trade correctly and maintain the right balance of risks you can surely emerge a winner in stock option trading.

1. The stock’s past history and movement.

2. Expected earnings reports of the stock’s parent company.

3. Volatility and volume of shares traded daily.

4. Any current news concerning the company’s growth or profitability.

5. The price of the option with respect to how you think the stock will perform. If you do not feel the stock’s movement will handily offset the cost of the option, plus the trading fees, then buying or selling the option would be fruitless.

6. Supply and demand of the underlying stock. (Industry group market action.)

Once you have decided upon which stock to pick, you next need to decide whether you believe the stock’s price is likely to rise or fall. (With stock options you can make money in either direction.)

By purchasing a Call option:

1. You expect the price of the underlying stock to rise, so you can then purchase it at the lower strike price, making a profit in the transaction.

2. You have the right to control 100 shares of stock for a fraction of the cost of purchasing the stock outright.

3. You are managing your risk by limiting the downside to the premium paid for the option. The major downside to buying any option is time decay. Your option expires within a finite period of time. If the underlying stock price behaves as expected, you will not need to be concerned about execution.

Having shown you the benefits of buying Calls over the risks of purchasing the stocks outright, we must emphasize the fact that buying short-term Calls has its associated risks as well. A Call buyer, especially a short-term Call buyer, is severely limited by the time-decay factor. The nearer to the expiration of an option, the less the option is worth, and the less time is remaining for the option to become profitable. Within the leverage used by gambling casinos (the house), the concept of short-term Call buying is completely understood, as well as exploited, as gamblers are considered short-term Call buyers.

Example: Consider your long-term Put, or Call, as a 6 to 8 month license to operate a casino. It allows you to capture short-term premiums; money that gamblers continuously give to you in attempting to beat the odds by speculating they will make profits on very risky bets. They feverishly feed the slot machines, ante up at poker, double-down on blackjack, or spin the roulette wheel. The odds are overwhelmingly against these short-term buyers. You, as the casino owner, continuously capture these short-term premiums, easily offsetting the expense of the license to operate the casino, then earning substantial, clear profits in the following months. They know the odds are with the casino owner, but they still take the enormous gamble on the slim chance they will hit a jackpot. The lottery works in the same manner.

On one side of the position, the transaction is definitely gambling, while on the other, the casino is simply engaging in business. Would you rather bet on the remote chance of a gambler’s rare, limited success, or rake in the steady, routine premiums captured from operating a successful business? Yes, occasionally a gambler does beat the odds to enjoy a limited, windfall return on his bet. For the casino owner, that is simply part of the cost of doing business. But we all know where the true, long-term profits lie. 30%, 40%, 50% and more, are common, and in short periods of time. The odds are with the short-term option seller, not the buyer.

When you choose a stock for short-term Call buying, you not only must carefully consider the proper stock for the type of option you are purchasing, you must also decide which direction the stock will move, then, that movement must occur within a specified, very limited period of time. Many investors have gone broke by attempting to make those same decisions. In short, time is not on the side of the short-term option buyer. It is on the side of the option seller.

Summary: 1. Buying stocks is risky.

2. Buying short-term options is less risky, but still risky.

3. Selling short-term options is the least risky, especially with a hedge, or insurance.

By selling a Call option:

1. You expect the underlying stock price to fall, so the option will not be exercised, but expire, worthless.

2. You can capture the entire premium that was paid to you, as profit. If the underlying stock price rises, you are obligated to sell 100 shares of stock at the lower strike price. If you do not already own those shares, you would then have to buy them at a higher market value, then sell them at the strike price, in order to meet your obligation. This situation is called a “Naked,” or “Uncovered” position, and is extremely dangerous. Anytime you sell a Call option you should consider buying the same option with a slightly lower strike price, and longer expiration date. This will reduce your profit potential, but will also reduce your risk considerably. (Remember the parallel twins, Risk and Reward

- If you want to reduce risk, you must also give up some degree of potential rewards. You may wish to lower your cost basis in the stock, to the extent of the premium received.

By purchasing a Put option:

1. You expect the price of the underlying stock to fall, allowing you to sell stock at the higher strike price, and thereby earning a profit.

2. This option is also used in a combination strategy as a hedge against selling Puts. We will explore that strategy later, in detail.

3. Buying Put options could also be used as a hedge, or insurance, against the possibility of a price drop in stock you already own. Consider the following:

You own 100 shares of ABC stock, and are concerned that the stock price could suddenly fall. You purchase a Put option on the same stock, with a strike price at current market value. If your stock falls in price, you would have the right to exercise your option and sell 100 shares of ABC stock at the higher strike price. The premium you paid for the option could be far less than the loss you would have incurred without that insurance. In this instance buying Puts acted as a hedge against the possibility of a price decrease in the stocks you already own. If the price of the underlying stock increases, your loss is limited to the premium you paid for the option. The option acts as an insurance policy against possible loss.

Selling a Put option without an opposing hedge -”Naked” You expect the price of the underlying stock to increase, causing the Put option you sold to expire worthless. You can then capture the entire premium paid to you, as profit. If the underlying stock price were to fall below the strike price, then you would be obligated to purchase the stock at the strike price, or pay the difference between the strike price and the stock price, if you do not want to own the stock. Your upside is limited to the premium received for selling the option. Your downside is potentially unlimited to the base value of whatever you could sell the stock for on the open market, or to the difference between the strike price and the stock price. This is a “Naked,” or “Uncovered” position, and should never be allowed to occur, unintentionally. Without the implementation of combination strategies, the main objective of the Put seller is to hope the option expires, allowing him to capture the entire option premium as profit. Nearing expiration, if the stock price moves below the strike price, changing the option’s value to ITM, and highly vulnerable to exercise, then the option seller must move quickly to buy back the option, perhaps lessening his profit potential, while also managing his risk. Even so, a small loss would be better than having to buy 100 shares of stock at inflated prices. Also, the loss can be immediately compensated for by simultaneously selling another Put expiring in the following month. We use OPM (Other People’s Money) to buffer downside risks, while buying more time for the stock price to rise.

Stock Option Trading, when done properly, can drastically reduce, or even eliminate, these two stumbling blocks to stock market success. In the first place, A trader of stock options never is not required to own the underlying stock in which an option is based. He or she can design a trade in such a way that downside risk is limited to the cost of the option, which in itself is a fraction of the cost of the stock. We capitalize on traders and speculators greed to get rich who purchase overvalued short term options bid up to inflated levels by an excess of demand over supply, by being the house or casino owner and capturing the inflated premium from the players or buyers. We buy reinsurance at a low cost by purchasing a longer term ( 5 to 6 months) out of the money option to sell the stock at a fixed price no matter how low it may drop. We buy this reinsurance ( puts ) to create a profitable hedge and sell overvalued puts repeatedly, month by month to bring the cost of our hedge down to zero and a credit so that we can enjoy a free ride capturing this inflated premium income. This strategy is known as diagonal put spreads and you do not need to pick a winner to profit.

Option trading, in and of itself, is not inherently risky. Options are simply tools. Imagine a big dial labeled, Options. You turn the dial one way and your risk goes down (as do your potential rewards). You turn the dial the other way and your risk goes up (as do your rewards, either in the form of upfront cash, or in the form of potential profits). In short, you can use options (for the right price) to reduce your risk, and you can use options (if the price is right) to generate lucrative income or receive other compensation in exchange for taking on someone else’s risk.

Let’s look at some scenarios that show each side of the risk trade.

Using Options to Reduce Risk

There are various option trading strategies you can employ to reduce the risk to your stock holdings. The price you will have to pay may come in the form of an actual cash payout to purchase that protection, or it may involve exchanging some of your future potential profits in order to acquire that protection.

Here are two trades that will reduce your risk:

Using Options to be Compensated for Assuming Someone Else’s Risk

If you are willing to assume someone else’s risk you can be compensated–and sometimes quite handsomely–for your trouble. The compensation may take the form of sharing the capital gains on someone else’s stock, or it may simply take the form of a cash payment.

Here are two types of trades in which you are compensated to assume someone else’s risk:

Conclusion:

The option trade examples above are all relatively simple but they illustrate the true nature of stock options. Trafficking in options is essentially trafficking in risk. No matter how elaborate and complex an option trade becomes, the core equation of risk is still present.

Developing and maintaining an awareness of this reality of options is crucial to your own option trading success. Whether you’re looking to reduce your risk or to be compensated for assuming someone else’s, a conscious awareness of what’s really happening in any given options transaction is invaluable. Once you know what’s really at stake, you’re in a much better position to consciously look for ways to accomplish your objectives as efficiently as possible. The outsourcer of risk will seek to reduce risk as cheaply as possible, and the assumer of risk will seek the highest compensation for the risk assumed.