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By: Billy Williams...
Stock option trading offers more flexibility, leverage, and limited risk than any investment vehicle today. At this point in financial history the availiability to access the derivative markets with online option trading now puts the power of these sophisticated instruments in the hands of the trader on Main Street as well as Wall Street. In contrast, the potential of these instruments can also be a little intimidating for some aspiring option traders because some strategies seem so complex. However, by gaining a foundation in four basic option strategies you can begin mastering the building blocks of all the available strategies that stock options have to offer. The basic strategies are four in number and are the long call strategy, the naked call strategy, the long put strategy, and the naked put strategy. A call option, or long call option strategy, is a bullish strategy that a option trader uses when he sees an upward bias in a company's stock. One call option allows you to control up to 100 shares of the company's stock and your reward potential is theoretically unlimited. His risk is limited to the price of the call option he purchased though however an option trader must factor time into his investment decision because time decay works against his position as the expiration date for his call option approaches. The naked call strategy, or the short call strategy, is a bearish strategy that is considered to be somewhat of an advanced strategy by most stock brokers. The strategy is used when a trader believes that a stock is going to decline and you allow another trader to sell you a call option which is where you get the premium from that option. You do this because you feel the stock will fall and it allows the other trader to hedge his risk by selling you the call option. Time decay works for you in this trade but your reward is limited to the call option premium while your risk is almost unlimited if the stock rallies. The long put option strategy is similar to the long call except you are bearish on a stock. When you go long a put it means you are buying a put option that controls 100 shares of a stock because you believe the stock is going to decline in value. Your risk is limited to the premium paid for the put option while your reward potential is almost unlimited. Time decay works against you on this strategy so if you use it be sure to give yourself enough time to profit. The short put strategy, also called the naked put strategy, is used when you are expecting a stock to rise in price or remain at near the same price level for a given amount of time. Your reward is the cost of the put option if the stock rises or remains static but your risk is theoretically unlimited if the stock declines. If it falls in price and hits your stop loss point you must buy back the puts to limit your risk. This is a bullish strategy that is a short term income generator when used properly. There are over 60 option strategies to trade for huge returns in today's markets and how you use them can be for your advantage but it all starts with these four basic strategies detailed here. By taking the time to see how each of these strategies work in the market individually you will begin to understand how they work in combination with each other. Soon, you gain mastery of stock option trading and how they are implemented to put you in the best position to profit while limiting your risk.
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