Up until this point, we have covered option contracts and how they can benefit investors who want to own stock or hedge against stock they already own. This is an important technique to grasp in order to build a solid foundation upon which to build. If you are having difficulty with any of the prior content, please go back and review before moving on.

From now on our educational content is going to focus on how option contracts can be used to profit from speculation of expected future prices.

Suppose an investor is bullish on a underlying stock but not interested in actually owning the stock? By using option contracts to speculate on future prices investors can profit without ever having to own the underlying stock. Suppose that an investor purchases a call option one week and sells the call option to another buyer the next week for a higher premium than they originally paid.  This would allow the investor to profit from the increase in the premium value of the contract (which is the result of the underlying stock price increasing).

Two investors are bullish on Goldman Sachs, whose stock is currently trading at $170 per share.
Investor A purchases 100 shares of the stock which costs $17,000.
Investor B decides to purchase 10 GS December 180 call options for $4.00 ($4,000).

After two weeks the underlying stock has moved up to $185 per share.
Investor A would have profited $1,500 while risking $17,000.This is a return of 12%.
Investor B would have profited $6,000 while risking $4,000. This is a return of 150%.

Or perhaps the investors are bearish on Goldman Sachs and want to profit from a move down in share prices. Again, by using option contracts to speculate on future prices investors can profit without ever having to short the underlying stock. Suppose that an investor purchases a put option one week and sells the put option to another buyer the next week for a higher premium than they originally paid.  This would allow the investor to profit from the increase in the premium value of the contract (which is the result of the underlying stock price declining).

Two investors are bearish on Goldman Sachs, whose stock is currently trading at $170 per share.
Investor A shorts 100 shares of the stock which costs $17,000 in margin.
Investor B decides to purchase 10 GS December 160 put options for $3.00 ($3,000).

After two weeks the underlying stock has moved down to $155 per share.
Investor A would have profited $1,500 while risking $17,000.This is a return of 12%.
Investor B would have profited $2,000 while risking $3,000. This is a return of 66%.

Clearly, using option contracts to speculate instead of stock  has advantages of less risk and better returns. Of course, because option contracts expire, investors run the risk of time running out of time- something not present in stocks. With that being said, even in this case the investor still has much less capital at risk buying option contracts versus buying stock.

These are just some examples of how speculation can be profitable trading option contracts. But before we get into speculation any deeper, it is important to learn a few more basics. Lesson three will deal with a variety of beginner topics we have not yet covered.