Kardec Trader explains options trading through a real-estate deal: pay $1,000 to buy a $200,000 house within a month. If it drops to $150,000, you lose only the $1,000. If it rises to $300,000, you buy at $200,000 and pocket a $100,000 profit. Limited downside, leveraged upside.
$200,000
$1,000
One month
$150,000
$300,000
So let's say you want to buy a house. Let's say the house costs $200,000. Let's say you don't want to risk the $200,000. What you would do is you would get into the contract from the person selling and say, hey, I will buy this house in whatever the time period is. So we'll set the time period of one month, that is our expiration for this contract. And the value, let's say, is $1,000. Basically you have one month and the person who sold you this contract, they cannot sell this house to anyone else because they're in a $1,000. There are a couple of scenarios that can happen in the next one month. Let's say something happens in that neighborhood, the value of that house drops and it drops to 150,000. Now, if you had bought that house within that two week period time, you would have lost $50,000. Because your only risk was that 1,000. You can simply walk away from the deal and this will be your only loss. Let's say the second scenario, the value of the house increases. Yeah, right. So let's say it goes to 300,000. It happened within your expiration time. The contract allows you to buy the house for 200,000. So you buy the house, you can sell it, flip it, and your profit now will be that $100,000. That's how options work.
