Editors' pick: Originally published Sept. 22.
Sure, you know how to buy and sell a stock or a mutual fund. You know what an ETF is, and terms like "ex-dividend," "DRIP" and "short-selling" don't make you sweat.
But now that you're comfortable buying and selling stocks, there's a whole new world out there -- options. Options allow you to participate in the stock's day-to-day price movements without actually owning/shorting the stock. And you get in on the action at a much lower cost. These fast-moving and fast-money trades combine volatility, leverage and speculation to allow traders or investors to create additional wealth.
However, if you're not careful, they can blow up in your face and cause you to lose a small fortune.
Don't worry, though: while not for the brand new investor, options trading can be quite lucrative, and it's important to understand these tools, even if you don't use them right away.
Before you decide whether you should buy the Apple (AAPL) - Get Report September $125 calls or sell the Tesla (TSLA) - Get Report November $250 puts, you need to know what these options terms mean first.
Here are three options terms every retail investor should know.
A call is a bet that the stock price will move higher. So if you're really bullish on Apple going into its October earnings, you might buy a call.
However, you don't have to buy the stock, if you don't want to, says Adam Warner, author of Options Volatility Trading and a former market maker on the now defunct American Stock Exchange.
"It [a call] gives you the right but not the obligation to buy a specific stock by a specific date at a specific price," says Warner, who's been trading options for 28 years. "It helps minimize risk because you can only lose what you pay for the call, but it gives you unlimited upside."
A put is the opposite of a call -- it gives you the right but not the obligation to sell a specific stock by a specific date at a specific price.
Warner says: "It's safer than shorting and it's also a good hedging tool. You're hedging a long position, so it helps to hedge against downside risk."
So if you're really bearish about the prospects of a company like Mylan (MYL) - Get Report or Wells Fargo (WFC) - Get Report , both of which have seen tremendous amounts of negative press in recent days and weeks, buying a put on either of these companies may make sense for you.
Strike Price/Expiration Dates
Now that you know what a call and a put are, what are those numbers and letters next to the various options? Those are the specific strike prices and expiration dates.
"The strike price references the specified price of the call or put contract," says RealMoneyPro contributor and former hedge fund manager Timothy Collins. "The expiration date references the time period of the call or put contract."
So if you think Apple shares will hit $115 before November, you might buy the $115 Apple call option to help capture some upside in the stock.
Options trading isn't easy and it isn't for the faint of heart, so approach with caution. But understanding the terms and what they mean can increase your chances of success rather than wandering blindly into the fray.