Another Way to Profit in Stocks
Another Way to Profit in Stocks
In the earlier articles, you have been introduced to the concepts of the stock market, stocks, EPS, capital gains and many other terms that are important in dealing with the stock market. So far, you have the impression that there are two major ways to earn profits from the stock market. This is through the quarterly dividends or EPS and through capital gains. In this article, I will introduce you to another way to earn profits from stocks that is apart from the EPS and capital gains. This third way of earning from stocks is through writing options.
Of course, as a beginner, you may be wondering what a stock option is. A stock option is an agreement or contract between two parties whereby one binds himself to sell (in calls) or to buy (in puts) shares of stocks at a given price within a given specific term or period whereas the other party binds himself to pay a consideration to be able to have the choice of exercising the contract. Every stock option has the following elements: a writer, a holder, a premium, a strike price or exercise price, the underlying stock and the exercise period. A writer is the one that owns the stock, creates the contract, and offers this contract to another for a price. The writer is the one that has the obligation to either sell or buy the stocks that is subject of the stock option. A holder is the person that pays the writer to have the choice of buying or selling or not buying or not selling the stocks. The holder has no obligation to exercise the stock option but he has a right to demand the implementation of the option if he wants to. The premium is the consideration that the holder pays to the writer to have the right to exercise the contract. The strike price is the price where the stock option can be exercised. The underlying stock is the stock subject of the stock option and the exercise period is the period where the holder can demand the performance of the contract. There are two kinds of stock options: calls and puts. Calls give the holder the right to buy shares of stock at the strike price whereas puts give the holder the right to sell the shares of the stock at a certain price. This may seem a bit confusing now, but the concept of stock options will become clearer in the succeeding articles.
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