Option Trading has been around for decades now. This practice’s first application traces its origin back to ancient Greece, where individuals would make forecasts about the olive harvest.
Currently, this lucrative strategy is in most global financial markets such as stocks and bonds. When options are correctly executed, they offer more perks compared to trading stocks solely.
However, trading of options is no walk in the park. Some risks are involved. And if the investor isn’t careful, he may end up losing money within a short time, which explains the numerous disclaimer remarks given by options trading brokers.
To avoid such pitfalls and enjoy the earning potential of options, entrepreneurs must grasp the basics. So, what exactly is options trading? And what benefits does it offer the investor?
Understanding Options Trading
What are options?
Trading options seems like a game for the big players. But it doesn’t have to be. Once you understand the fundamentals, you will appreciate the value of this venture. So, what are options?
Options are defined as derivative contracts that give a buyer a choice to trade a specified value of an underlying security at a fixed price and by the expiration date. Within the scope of options trading, there exist two types of contracts between buyers and sellers: calls and puts.
You can utilize the working mechanisms of options in various ways. Other than enabling the investor to trade different types of assets and instruments, they can also speculate or avoid risk.
Exchange-Traded Funds (ETFs) and equities are examples of commonly traded securities.
How does option trading work?
As mentioned, option trading is regulated by two types of contracts – calls and puts. And they are influenced by either bullish or bearish market trends.
A call option contract allows you the right (but not the obligation) to buy a stock at the strike price by a specific date before the option’s expiration date.
In a bullish call, the investor sells the right to buy a security at the option’s specified price, in the belief that the stock will go higher. There is some risk involved, but the plus-side is you make money even if the stock goes down.
On the other hand, a bullish call option gives a seller the right to dispose of assets to an investor at the option’s highest price. It is considered as insurance because the risk is similar to buying security. The advantage is you make money when the stock value rises.
A put option contract allows the buyer the right, but not the obligation, to sell underlying assets at a stated price by expiry date. In the event of a bearish put, an investor can buy the right to sell an asset at the option’s strike price.
The buyer still makes money when the value of the stock decreases. The maximum amount of risk is equal to the premium paid.
How to get started
Step 1: Get an option trading account.
Usually, brokers prefer giving accounts to experienced individuals. They will demand information to ascertain if you qualify as an options trader. Ensure you also screen the options trading brokerage firm to find the best fit for you.
2: Project Step the direction the option will move
The direction the option moves determines whether you go for a call or put option contract. Speculate if an option will rise above or fall below the strike price. For instance, if you think an asset’s value will drop, it is advisable to buy a put option.
Step 3: Define the time frame in which to exercise the options
Predetermined time limits bound all stock options contracts. The expiry date marks the final day you can exercise the option. The length of contracts varies from daily and weekly options to those taking months or years.
An option’s value declines the closer it gets to its expiration. If it goes past its due date, it is rendered worthless. Therefore, opt for option contracts with a more extended period, which also gives the asset or instrument more time to move, to get a decent payout eventually.
Benefits of Options Trading
You can trade options involving a broad array of assets. Other than shares, you can apply options trading to indexes and instruments such as agricultural produce, forex, and energy. You can even trade multiple assets generating more income.
Option trading is highly favored by traders with limited pockets. It provides more leverage compared to other forms of trading in the financial marketplace. Therefore, one can quickly optimize a small investment to give maximum profit.
And if you wish to save more, opt for an online option trading brokerage firm. They tend to offer fairer prices compared to their brick and mortar counterparts. You will avoid paying highly stated commission fees
As stated earlier, the amount of risk associated with option trading is limited. You can assess market movements and trends to minimize your exposure to risk while increasing your probability of success. You can further predict future positions to determine the best entry and exit points.
Option trading presents modern entrepreneurs with a lucrative opportunity to make money with online trading. Thanks to their versatility, you are able to adjust to any changes that occur. Trading options is a more strategic and cost-effective solution to increase returns on your investment.