Considering the overhead costs that Marco Polo must have incurred on his camel rides to trade in silk it is not altogether surprising that he decided to stay in China for forty years after he arrived there. His overhead costs would have been high. By contrast, modern options trading allows for considerable profit and the overhead costs are relatively slight.
Options are contracts that can be bought and sold, hopefully at a profit, but possible at a loss. The contract confers the right to buy or sell and underlying asset. The underlying asset may be a well traded share such as a commercial bank or mining company. One can also trade in commodity options, buying or sell commodities such as oil or copper.
The fact that such contracts are derived from trade in the underlying asset is why they are called by the generic term of derivatives. Market makers create the market in these contracts and earn a premium on each sale in them. This is the risk free profit that they earn as they transfer the risk from themselves to traders in the market.
The risk is taken on by traders who hope to enlarge their profit by leverage. The contract that they buy enables them to trade in larger amounts of the underlying asset than would be the case if they invested a large amount of money to buy only a few shares in the underlying asset directly.
For example, it could cost a thousand dollars to buy an underlying share but only one hundred dollars to buy a derivative contract that will provide for six or seven times the profit that could be had from buying the underlying share. Sadly, the lever can be applied in the reverse way should the trade turn sour and loss could also be six or seven times greater.
Aside from leveraging, trading in derivatives allows grater flexibility. A trader may potentially benefit from a declining price trend by buying a ‘put’ option which allows the right to sell the underlying asset. If the put is bought at a thousand dollars and sold at a much lower price then the different is the profit to the seller. So an astute trader may profit from declining price trends as much as he does from rising prices.
In some quarters put options are condemned as artificial ways in which stock markets can decline precipitately due to the number of traders jumping onto the ’sell’ bandwagon. Others believe that put options act as safety valves that prevent disasters such as the Great Depression. This is because a put option will be sold at some point and the sale will mean that another trader has taken an opposite view, so helping to maintain a balance.
The opposite of puts are call options. Holders of these contracts are expecting prices to rise so that they may benefit from the increased value of the underlying asset. Call options also help to keep markets stable because holders will take profits at some point, discouraging wild gyrations in profits and unhealthy spikes of the kind that saw tulip bulbs being sold for the price of a house in the tulip market bubble.
Trading may take many different forms. Some people prefer to rent a store, buy stocks of groceries, hire staff and take a small profit from each small sale. Others might think it more exciting to buy a computer, work from home to one’s own hours and enjoy this modern income generating strategy.
Born To Sell’s website offers additional information about covered call options. A good covered call calculator will save you a ton of time when doing covered call options investing.