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What to Know About Stock Options

If you've been investing for a while, you have probably heard about stock options, or some exotic form of stock option investing such as binary options. There are millions of stock options traded on the exchanges everyday.  Stock options have also become a popular way to incentivize and encourage employees to work toward the good of their company.  Let's start by looking at what a stock option is and then explore a few of the more popular types of options that are available for investment.

What is a Stock Option?

Quite simply, a stock option is the opportunity to buy something at a given price for a given time.  For example, in real estate, you may get an offer from someone to buy your house for a given price and for a set period.  In its simplest form, this is an option.  When we refer to stock options, we are talking about the option to buy or sell a given stock at a given price during a set period.

The price of an option depends on the likelihood of what that option will be worth on or before it expires.  The way a stock option is priced is beyond the scope of this article, but it has a lot to do with risk and return - much like other investments.  If you'd like to learn a little bit more we'll cover the two types of stock options you'll most likely run into.

The different kinds of stock options

Exchange Traded Options. This type of option refers to the options that trade on organized exchanges.  All exchanges are now electronic so really this means any type of option that you trade through your online broker or using a trading platform.  The most common types of stock options are calls and puts.  A call option is the right to purchase an underlying security and a put option is the write to sell an underlying security for a given price.

Besides buying put and call options, you can also write options.  By writing an option you are creating an option that someone else would buy.  These types of transactions are typically left to reallly experienced traders, but it doesn't hurt to be aware of them.  Another type of advanced option is known as a binary option.  Binary options have only two outcomes.  They either expire worth a set dollar amount or they expire worthless.

If you are interested in learning how to invest in typical stock options, traditional put and call options are your best bet.  However, most investors use options to hedge their portfolio from risk.  Buying and selling individual options is usually more speculating than investing.  You should know the risks and do some research before you proceed.

Corporate Stock Options.  The other type of option that you've probably heard people talk about are corporate stock options.  These are the stock options that are granted to employees to incentivize them to work.  Corporate stock options are granted to employees and vest over a long period of time, often many years.  This is quite different from exchange traded options that typically last for months, weeks or even hours.

These types of stock options are similar though, as they allow you the option to purchase stock at a set price for a given period.  In your employer's case, they grant you these options to encourage you to help raise the stock price of the company.  The higher the stock price, the more your options are worth.  These types of options are not transferable like other options, and because they are given to you at no charge and are for long term, they do not offer nearly the risk of the other options.  However, you should never rely on just stock options to save your money.  Make sure you keep your portfolio diversified.


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