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Option trading is typically defined as a contract between a couple of parties in which one of the parties has a right but not an obligation to buy or sell a certain amount of underlying security at a certain price within a specific time frame. The good leverage via option trading draws ever more spectators.

Investors can use option trading to help protect a portfolio of stocks against sudden downward pressure. This is a very conservative strategy where puts are bought to act as a hedge. Investors thereby buy the right to sell stock already owned at a particular price regardless of what the market is doing. If the price of the underlying stock continues to rise instead of falling, this strategy will limit the portfolio's upside potential reducing it by the cost associated with the purchase of the puts.

Another conservative option strategy is sell calls while owning the underlying stock. This is called covered call writing; it is a strategy often used by investors to generate additional income on stocks already in their portfolio. This strategy provides limited downside protection in case stock prices fall.

If stocks don't take too severe a nosedive, a covered call writer can lessen the impact of a decrease via receipt of the call sale premium. On the other hand, should stocks plunge precipitously, a person who invests will still suffer a loss, since the amount of the premium will not be as great as the amount lost by the underlying securities.

Investors with a high level of risk tolerance may wish to leverage relatively moderate sums of money. Buying options is associated with rights but not obligations. Traders may purchase calls with the expectation that they will be able to sell these later at a profit- if the price of the underlying security goes up. Speculators buying call options or selling put options, hope to profit from rising prices.

If you think the price of the underlying security will go down, then you make money by buying a put now and selling it at a higher price later. To benefit from falling prices you make money by buying puts or selling call options. This is a way to leverage profits but it also leverages losses if you bet the wrong way. If are betting on increasing prices and the option expires before the price goes up, you can't lose more than the amount you paid plus commissions.

Conversely, speculators who disposed of options could forfeit much more than the premium they earned for liquidating them. If you find all the terminology confusing regarding option trading, do a little research with the help of the Options Dictionary as a part of your stock option education.

The practice of option trading is defined as a contract between two parties in which one party has the right, but not the obligation, to buy or sell a specified amount of an underlying security at a specified price within a specified time. The great leverage provided by trading option contracts is attracting more and more speculators. The wise investors choose the option strategy best suited for maximizing gains while minimizing risks. With a little research as a part of your thorough stock option education you can make money by trading options too.