Trading Strategies
Buying stock is a trading strategy that most people understand. In practical
terms, traders who buy stock are generally not concerned with the literal
ownership stake in a corporation, just the opportunity to profit if the stock
rises. Although it’s important for traders to understand that the price of a
stock is largely tied to the success or failure of the corporation, it’s essential
to keep in mind exactly what the objective tends to be for trading a stock: to
profit from changes in its price. A bullish position can also be taken in the
options market. The most basic example is buying a call.
A bearish position can be taken by trading stock or options, as well. If
traders expect the value of a stock they own to fall, they will sell the stock.
This eliminates the risk of losses from the stock’s falling. If the traders do
not own the stock that they think will decline, they can take a more active
stance and short it. The short-seller borrows the stock from a party that
owns it and then sells the borrowed shares to another party. The goal of
selling stock short is to later repurchase the shares at a lower price before
returning the stock to its owner. It is simply reversing the order of “buy
low/sell high.” The risk is that the stock rises and shares have to be bought
at a higher price than that at which they were sold. Although shorting stock
can lead to profits when the market cooperates, in the options market, there
are alternative ways to profit from falling prices. The most basic example is
buying a put.
A trader can use options to take a bullish or bearish position, given a
directional forecast. Sideways, nontrending stocks and their antithesis,
volatile stocks, can be traded as well. In the later market conditions, profit
or loss can be independent of whether the stock rises or falls. Opportunity
in option trading is not necessarily black and white—not necessarily up and
down. Option trading is nonlinear. Consequently, more opportunities can be
exploited by trading options than by trading stock.
Option traders must consider the time period in question, the volatility
expected during this period, interest rates, and dividends. Along with the
stock price, these factors make up the dynamic components of an option’s
value. These individual factors can be isolated, measured, and exploited.