Options trading is becoming more and more common these days even though it has been around for some time. On this blog, we will provide useful information on what options trading is, and how it works.
An option is a contract that allows you as the investor to buy or sell assets such as stocks, ETFs, etc. at a certain rate over a certain period of time. Options trading involve betting on the future value of these assets. Therefore, as the investor, you get into a contract that allows you to buy or sell these securities at a specific price at a later date and time.
Doing well in the options industry is easier when there are investing strategies involved. Options trading strategies can range from simple, to complex (especially for beginners.) But as long as you understand the basics, you’re good to go.
All strategies involved are based on two main types of options: call options and put options.
Call Options
A call option is a contract that gives a buyer the right to buy an underlying asset at a specific rate (known as the strike price) over a specified period of time (the expiration date).
When you’re buying a call option it means you’re hoping for the price of the asset to go up to make a profit.
The market price of the call option is called a premium. It is the amount you pay for the rights the call option provides.
Put Options
Put options are the flipside of call options. A put option is a contract that gives an investor the right to sell an underlying asset at the strike price anytime before the expiration date. As the call option, the premium price is the amount the investor pays for the put option.
A put option premium increases when the price of the underlying asset decreases. Conversely, if the premium decreases or becomes worthless, the stock price of the asset increases.
Going long means you are buying the option hoping that the price is going to rise (call option) and exceed the strike price by expiration date. The upside to this is if the stock continues to increase before the expiration date, the call will keep rising too.
Going short is the opposite of going long. The trader sells and hopes for the stock price to be more than the strike price by expiration date. In exchange for selling a put, the investor gets a premium.
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Option Trading Platforms
If you’d like to get started on trading options, you need to set up a brokerage account with a platform that supports them. Different brokers have different requirements. You, therefore, need to understand the platform’s advantages and disadvantages. Platforms such as Webull, Ameritrade, and Interactive Brokers offer options trading.
How do you determine which one is best for you?
• Low costs
• Account minimum
• Technology
• Customer support
• Platform quality
• Unique features
1. The risk of losing your principal. Like other securities such as mutual funds and stocks, options are not as safe either. You can lose your entire capital, and even more.
2. Time decay. As mentioned earlier, options have an expiration date. The closer you get to that date, the faster the premium deteriorates.
3. Costs are easily impacted. Depending on some issues such as getting closer to the expiration date, and the connection between the stock price and strike price, slight movements in stock can lead to a significant movement in the underlying options.
It’s helpful to have a basic understanding of options markets and trading or investing. This course: Stock market fundamentals is a six-part course that covers the basics of stock market investing. Click here to master the nuts and bolts of options trading.
