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OK, let’s cover some basics about option trading. First of all, there are call options and put options. A call option will go up in value when the underlying security goes up in value, and a put option will do the opposite… it will go up in value when the underlying security goes down in value.

Ohhh, wouldn’t it be nice if option trading was that simple? Unfortunately, it isn’t. There is this whole idea of time decay and volatility. It is entirely possible to but a call option on a stock, then sit back and watch the underlying stock go up in value while your call option LOSES value….

How can this happen? Well, the explanation gets a little complicated, but the deal is like this… an option is only good for a certain period of time. For instance, let’s say three months. When you buy the call - let’s say it is a stock option - the underlying stock is at 60. Your option has a strike price of 70. That means you can buy the stock at 70 by using your call option.

Obviously, with the price at 60, you are not going to want to excercise your option and buy the stock at 70. But you are betting that the stock’s price will go up above 70 in the three months before the option expires. In that case, your option will be in the money.

If it is a strong stock and a strong market, then maybe you figure the odds are pretty good it will get above 70 in those next three months before the option expires. But what if you only had two days before the option expired… all of a sudden your odds go way down.

And that is what is underlying the whole idea of time decay. With three months left, that option is worth a lot more than what it is if there are only two days left.

Trading options can give you some amazing potentials… but you really need to be on top of what you are doing. There are lots of types of options available: stock options, index options, future options, and long term options - LEAPS.

There are lots of sources for information about options, and you would be well served to study up on options before you get involved in trading options…

Here is a definition of a stock option:

A stock option is an option with a stock as the underlying equity… in other words, the stock is the security that the option is based on. The option is a contract that gives you the right BUT NOT THE OBLIGATION to buy or sell shares of underlying stock, at a predetermined price for a specific amount of time.

Well, that definition of an option should be close… please check with your investment advisor or broker before you invest any money in options or try to trade options.

That is the problem with trading options… they are so darn complex. After trading in the markets for years, I still tend to shy away from options. They give you all kinds of flexibility, and there really are some great option trading strategies… but you really need to study hard and be prepared to spend some time bending your mind around options trading. It isn’t simple.

One of the key features of options that you don’t see in other types of securities is the whole factor of timing. It is very possible to get the direction of the market correct in an option trade, and still lose money due to the time decay factor.