Trading stock options as an investment tool is an often misunderstood trading concept by both traders and investors yet, once understood, can be very powerful and flexible tool in your investment choices. Consequently, as a result of there potential for profit and flexibility they are often view by many in the investment community as too complex to implement effectively. However, if a few basic concepts of stock options are understood such as types of options offered, leverage, risk control, time, and strike prices then beginning traders and investors can avoid common misconceptions of this powerful investment alternative.

It is vital that you understand that there are two types of options that are commonly available on exchange traded companies are called "calls" and "puts". Calls are purchased when an option investor believes that the underlying instrument, or stock price in this case, is about to rally and go higher. Put options, however, are purchased when a particular option investor believes that the share price on the company is about to fall and go lower. Once you understand the directional bias of each option alternative you understand more effectively your available choice when speculating on the direction of the stock you are analyzing.

The second factor to understanding stock options is that they offer one of highest sources of leverage by allowing you to control blocks of 100 shares per each option. For example, if you bought 100 shares of a $60 stock then you would have $6,000 invested but you would only need a few hundred dollars to control the same position with options. If your $6,000 worth of stock rose from a share price of $60 to $72 and you sold then you would realize a gain of 20% or $1,200. But if you owned call options on the same position you could conceivable earn a 200% or 300% gain!

Now, if you are starting to realize how powerful stock options are by offering you this kind of leverage then you will understand after reading the next few sentences that there potential for risk control is unparalleled! You see, when you purchase an option on a particular stock whatever the cost of the option is the only portion you actually risk. For example, if you buy a call option on a $60 stock that you believe is going higher and then the next day the CEO for that company announces the company's bankruptcy which results in the stock falling to zero the most you can lose in that scenario is $300. Whereas if you owned 100 shares at $60 a piece or a $6000 you could lose then entire $6000!

With options you have an enormous advantage when trading the markets but it is very important that you understand the relationship between time and stock options. Options have a limited shelf life in that they are assigned certain time periods before they expire worthless. These time periods, also called expiration periods, can vary from 30 days to several years with expiration days typically the third Friday of the month. Understading this relationship is crucial when factoring the average holding period for a trade with whatever trading method you are using and the type of stock option you are selecting. If your average holding period for a trade is 2 months then you want to select an option two months from expiration at a bare minimum. Realistically, you want to select a option that is two months out plus another month from expiration as time decay quickly erodes the value of an option that is less than 30 days from expiration.

The other success factor you must come to understand when trading options is understanding strike prices. Strikes are terms assigned on the price of an underlying stock of a publicly traded company. If, for example, ABC company's share price is at $50 its strike prices on it's available options might be a $45, $50, and $55 which you can observe in the price tables of any financial newspaper. Now, each strike price has certain pros and cons depending in large part your particular option strategy but, for now, knowing what strike prices are and understanding how to implement them in your trading decision process will you help you make the most effective selection choice.

Understanding stock options and their role in your investment choices provides you with enormous potential for high returns as well as limiting your risk. There flexibility allows you to potentially profit from rising markets, falling markets, markets that are range bound, and protecting your stock portfolio from unexpected volatility in the markets. Take some time and reread this article as well as similar articles along with studying any financial newspaper that offers price option tables. The time you invest in understanding these powerful investment tools can help you take advantage of their enormous potential and improve your bottom line.