What
is options trading?
Options traders can buy contracts that give
them the option to buy or sell an underlying asset for a certain price — called
a strike prices — at a certain time.
Say you buy an options contract giving you
the right to buy a stock for $10 for the next 30 days. Even if the actual price
of the stock has jumped to $30 on that 29th day, you can still buy that stock
for $10.
Options traders are speculating that an
underlying asset’s price will move one way or another. Stock option contracts
tend to represent 100 shares of the underlying stock. But stocks aren’t the
only option; investors can also buy and sell options on other assets, like
bonds, commodities and exchange-traded funds (ETFs).
There
are two main types of options: calls and puts.
What
are call options?
Buying a call option gives you the right, but
not the obligation, to buy an underlying asset for the strike price price
during a certain period of time. You’re calling it away from another investor
at a fixed price.
If the share prices skyrocket, you can see a
much greater return by owning an option than you would owning just the shares.
And if you buy this type of option, you can only lose the money you spent on
it. But when selling one (shorting the call), your potential loss is unlimited
unless you also own the underlying stock.
What
are put options?
A put option gives you the right, but not
obligation, to sell an underlying asset for the strike price during a certain
period of time. You’re putting the asset away from you at a fixed price.
Some investors use this strategy to hedge
against risk while others use it as a way to bet against the price of a
particular stock.
If you buy this type of option, you can only
lose the money you spend on the option. But again, if you sell the option,
you’re putting yourself at risk for a much bigger loss.
How
Do Trading Options Work?
Listen, there’s a lot of confusing jargon and
lingo that can leave you scratching your head, but every option can be broken
down into five pieces that will help you understand how they work.
Let’s break each one of those pieces down into bite-sized chunks:
1. The stock the option is based on. Every option is based on some kind of asset, in most cases that means stocks. And an option usually represents 100 shares of a particular stock that the owner of the option can buy or sell while the option is still active (that’s called “exercising the option”).
2.The type of option. Your option is either a call or a put—that’s it!
3. The expiration date. Do you know what an option and a gallon of milk have in common? After a certain date, they’re both useless! Every option comes with an expiration date, but that date could be anywhere from a few days to a few years from the time you buy the option. You can buy or sell the stock the option is based on or sell the option to somebody else who wants to buy it (that’s options trading—more on that later) up until the expiration date. Once that date comes and goes, the option simply disappears.
4. The “strike price.” If you choose to exercise the option, this is the price you’ll be able to buy or sell each share of the stock that the option is based on. If you have a call option with a strike price of $20 and the stock’s value rises to $45 per share, you’ll still be able to buy at $20. This also makes your option much more valuable on the options market!
5. The premium (or per-share cost of the
option). This is how much you’ll need to pay for the option. You might see an
option listed for $10. But it’s not actually worth $10. Remember, each option
represents 100 shares of a particular stock. That $10 is the per-share cost of
the option. So in reality, you would multiply the price of the option by 100 to
get your premium—which in this case is $1,000. That’s how much you would have
to pay for the option.
How
to start trading options?
If you’re thinking about trading options,
it’s actually surprisingly easy to start, and you don’t need a lot of money to
get going.
1.
Find an options broker
Your first step is to find an options broker
that works for you. If price is your only objective, then you might find apps
such as Webull or Robinhood interesting. If you want a more full-featured
experience, then you have numerous other choices. You may want to trade other
securities, so it can be worthwhile to look at the best all-around brokers.
2.
Open an account and deposit money
After you’ve found a broker that suits your
needs, you can open the account and deposit money. With your financial details
in hand, you can open most accounts in less than 15 minutes and then proceed to
funding the account. For some accounts, it may take several days for the money
from your bank to clear and become available in the brokerage account.
3.
Research your trade and pick your options
This stage is the single most important.
Before you place your trade, you need to know what you want to trade, and that
can require a lot of work. You’ll want to understand the company you’re
thinking about trading options in, so that you can make a smart decision.
What’s the competitive situation? Is the stock poised to rise in the near term
or longer out? From there, you can create an option strategy that fits your
expectations.
4.
Place your trade
Once you’ve decided which options you’ll be
trading, you can place your trade. It’s important to use a limit order (not a
market order) when placing options trades, or you might wind up with a much
different price for your trade than you expected.
While it won’t take a lot of money to get
started trading options, new traders should remember that one bad trade could
wipe out your whole bankroll. So it’s important to manage your risk carefully
and never trade with more money that you’re able to lose comfortably. While you
can make money quickly with options, you can lose it just as quickly.
Advantages
Of Options Trading
Options are one of the most versatile tools
of the financial markets.
Whether the market is moving up, down, or
sideways, options allow investors to enter the market with lower cost and lower
risk than trading the underlying asset on its own.
Online options trading platforms bring
comprehensive trading, investment, and research facilities to individual
investors.
Disadvantages
Of Options Trading
On the other hand, options trading has a
steep learning curve. It takes time to understand the full details of the
question “what is options trading?”
Conditions can change quickly, at times
making it difficult to close out a position if liquidity is an issue.
Also, depending on the platform you choose,
you will have fees associated with each transaction, so make sure to
incorporate those costs into your strategies.
As discussed above, investing the time into
education and to have a firm grasp of personal risk limits will set up a trader
for a better chance of success.
Frequently Asked Question (FAQ)
Q: Where
to trade options
Ans: InteractiveBrokers, TradeStation,
E*TRADE, tastyworks, eOption
Q: Why
is Trading Options attractive?
Ans: Options are attractive instruments to
trade in because of the higher returns. An option gives the right to the holder
to do something, with the ‘option’ of not to exercise that right. This way, the
holder can restrict his losses and multiply his returns.
Q: Is
option trading a good idea?
Ans: Option trading can be a better fit for
certain types of investors than others. Generally speaking, an option strategy
might work better for investors who: Are active traders and regularly follow
stock market trends. Understand concepts like implied volatility and what that
means for stock price movements
Q: What
are the 4 types of options?
Ans: There are four basic options positions:
buying a call option, selling a call option, buying a put option, and selling a
put option.
Q: Can
options trading make you rich?
Ans: Since an option contract represents 100
shares of the underlying stock, you can profit from controlling a lot more
shares of your favorite growth stock than you would if you were to purchase
individual shares with the same amount of cash. When your chosen stock flies to
the moon, sell your options for a massive profit.
Q: How
much money do you need for options trading?
Ans: around $5,000 to $10,000 to start
trading options.
Q: What
is the most successful option strategy?
Ans: The most successful options strategy is
to sell out-of-the-money put and call options. This options strategy has a high
probability of profit - you can also use credit spreads to reduce risk
Q: Who
is the richest option trader?
Ans: Dan Zanger holds a world record for his
trading one-year stock market portfolio appreciation, gaining over 29,000%. In
under two years, he turned $10,775 into $18 million.
Q: How
long does it take to learn options trading?
Ans; It takes about 3 to 6 months to learn
options trading from scratch. First, you need to understand the theory, and
then you need to practice order placements and finally start trading options.
Q: Can
I sell options without buying?
Ans; A naked call option is when an option seller sells a call option without owning the underlying stock. Naked short selling of options is considered very risky since there is no limit to how high a stock's price can go and the option seller is not “covered” against potential losses by owning the underlying stock.
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