Basically with option trading, you’re gambling that a stock price will go up or down. Options are traded as puts or calls. When you buy a put option, you think a particular stock will drop in price. When you buy a call option, you think a stock will go up in price.

Options are bought at a fraction of the cost of the actual stock and they are purchased on the basis of 100 shares. In other words, say you want to buy a put or call on ABC company at .8. That would be $80 for the option to buy (call) or sell (put) 100 shares of ABC by a certain date at $40 a share (This represents the value of the stock when you purchased your option.)

Scenario 1. If you purchased a call option thinking the stock would go up in price and it did, you would make money. Let’s say it went up to $50 a share. Because you bought a call option, you are guaranteed a price of $40 a share so you buy 100 shares of ABC at $40 ($4000) and turn right around and sell them at $50 a share ($5000) thus making yourself a tidy $1000 less the $100 you paid for the option. You net $900 less your brokerage fees. If the stock goes down, you don’t make squat, instead you lose $200.

Scenario 2. Let’s say you purchased a put option to sell thinking the above stock would go down in price. You gamble that in six months that stock will drop below the current price of $40 a share, so you buy a put to sell at that price for $200. If the stock drops to say, $30 a share, you buy a hundred shares at $30 ($3000) and sell your option at the guaranteed $40 a share ($4000), thus making a tidy $1000 less the $200 and your brokerage fees. If, on the other hand, the stock goes up, you’re out your $200.

I have oversimplified the workings of options investing. Forgive me for this, but there are many excellent sites that you can visit and learn the intricacies of options trading. One of the best I found is provided by the Options Industry Council. However, my main interest is to point out the risk of this investment philosophy.

Options trading is definitely a risky business and one you should approach with no more money than you are prepared to lose. You aren’t evaluating a company or index as a long term investment that, over time, will appreciate in value. You’re betting a certain event will happen in the market at a certain time and we all know that can get you into trouble. The market, because it’s dependant on the investors and investors can be unpredictable, can swing up or down drastically from day to day.

That said I must confess, I have played the options market and done quite well. It's a lot of fun. But, it takes knowing what you’re doing and it takes being able to handle high risk. I would never ever play the options market with money I was afraid of losing. I value a good night’s sleep too much to do that.

You will find a lot of sites on the WWW that promise a winning strategy if you buy a book, join something, or donate your hard earned cash for the stellar information you will be given. Let me suggest that you keep your money, do your own research and make your own decisions. There is no magic pill you can take that cures all your ills and there’s no magic formula that will guarantee your success in the options market. If you feel charitable though, and want to rid yourself of some cash, you can always send it to me. At least you’ll have no false expectations that way.