Option trading are generally defined as a contract between two parties in which one party has the right but not the obligation to buy or sell a specified amount of an underlying security at a specified price within a specified time. The great leverage through option trading attracts more and more speculators.

Option trading can be used as insurance to protect your investments from an unexpected slide in the market. This is what is meant by using a hedge. You buy a put option which gives you the right to sell a stock at a certain price no matter what the current market price of the stock is. If the price of the stock rises then eventually you will let the put option expire and lose what you paid for the put. This reduces the upside potential of the stock while protecting you from losses.

Another conservative option strategy is sell calls while owning the underlying stock. This is called covered call writing; it is a strategy often used by investors to generate additional income on stocks already in their portfolio. This strategy provides limited downside protection in case stock prices fall.

If the stocks were to fall slightly, the covered call writer can lighten the blow of a fall as he/she will still be able to get the premium they received for the sales of the calls; but, if the stock prices were to drop a great deal, the investors would still take a loss with money being the premium received for the calls will not offset the mounting losses which are in the underlying stocks.

If you are willing to take on a high level of risk then you can use leverage to turn small amounts of money into large profits. If you buy an option it gives you right to do something or you can let it expire worthless. Buy call options if you expect rising prices. To speculate on rising prices you either buy calls or sell puts.

Traders may also buy puts in the anticipation of selling them later at a profit- if the underlying security drops in price. Speculators buying put options or selling call options hope to profit from declining prices. Because speculators may not own the underlying equity, they risk losing substantial amounts. If a long option expires worthless, the options buyer cannot lose more than the amount paid for those options plus commissions.

Conversely, speculators who sold the options may lose a great deal more than the premium they got for selling. If you do not comprehend all the terminology of option trading, you may easily gain access to the Options Dictionary as part of your stock option education.