In life, it's good to have options. The same principle also applies to investments. Like stocks and bonds, options are assets you can invest in. Depending on how you use them, options can generate capital gains, reduce market risk and generate income.

For many people, options are somewhat disconcerting. First of all because of their jargon: call options, put options, futures, forward contracts, swaps, strike price, option premium ... there are even short buy and sell options. 

But hold on! 

While it is true that some option strategies can be complex, trading stock options can be quite simple. The key to options trading is to form an opinion about what will happen with an underlying asset. 

I also recommend finding a great mentor.

Perhaps the best mentor is David Jaffee from BestStockStrategy.com.

What is a stock option? 

An option is simply a contract between a buyer and a seller through which one speculates on the future price of an underlying asset, such as a stock. 

Since this is a contract, buyers and sellers have certain rights and obligations to the other party. 

As with equity investments, buyers want to pay the lowest possible price for the option, while sellers want to receive the highest possible price for the option.

There are two main types of options: call options and put options. 

Call options give buyers the right to buy a security at a predetermined price, while put options give buyers the right to sell a security at a predetermined price.

Selling options allows options traders to turn themselves into insurance companies.

During a bull market, traders will sell put options, collect premium, and as long as the undelrying stock does not fall below the strike price, then the sellers of those options will keep the option premium.

For example, let’s say that Amazon (AMZN) is trading at $2,100. An option trader can sell a put option with a strike price of $1,800 and receive $10 per share. As a result, as long as Amazon doesn’t fall below $1,800 at the expiration date, then the put seller will keep the entire $10 / share.

If Amazon falls below $1,800, then the trader will buy Amazon at a price that’s $300 below the current market price.

How do options differ from stocks? 

The main differences include the following: options have an expiration date and a strike price; options do not have shareholders' rights and do not give right to dividends; and options usually cost only a fraction of the price of the underlying asset.

How is the price of options established? 

Options are called "derivatives" since their price is derived from the value of the underlying asset. 

The price of an option, the premium paid by the buyer, is determined by factors such as the price of the underlying asset, the term to maturity of the option and the volatility of the underlying asset.

Suppose we believe that the price of a stock will increase. 

This is the first step: form an opinion. To follow up, we could sell a put option. If we are correct and the share price increases, we will be able to keep 100% of the premium collected. 

If we were to buy options and the underlying price moved in our favor, then we have two choices: “exercise” the option to buy the share at the strike price agreed in the contract, assuming that it this is now below the current market price, or sell the option contract at a profit, the price of which will also have increased due to the rise in the price of the underlying share.

In general, we try to SELL options, instead of buying them because by selling them, we take advantage of time decay (or theta). 

By selling options, we turn ourselves into insurance companies. David Jaffee primarily teaches his students to sell options and in 2019, he won 100% of his trades and experienced a 117% profit (watch this video about his trading style).

We might also believe that the price of one of the stocks we hold will increase, but only very gradually. 

Again, this is an opinion. To try to make a short-term gain on a stock, it is possible to sell a covered call option. If the share price remains below the exercise price, we can then keep the shares and the premium from the sale of the option. This strategy can be a good way to generate additional income from investments we already own. 

However, if the share price goes up, we would be forced to sell the share to the option buyer, at the exercise price.

Want to Learn More?

To learn more about how to increase your returns while reducing risk, please visit David Jaffee at BestStockStrategy.com

David Jaffee has taught over 1,000 students and is a former Wall Street investment banker. He graduated with honors from an Ivy League University and is the best options trading coach available.

You can enroll in his Options Trading Education Course at https://BestStockStrategy.com/memberships

David Jaffee also offers live option trade alerts. It’s $19 for a 7 days trial and then $349 / month.

You can also subscribe to his YouTube channel at https://Youtube.com/BestStockStrategy

David Jaffee from BestStockStrategy.com