Trading options is one of the many derivative alternatives of making money on the financial markets. Trading in any form of derivative is more risky than buying and selling stock as your positions are leveraged. This means that you are putting a smaller amount of money down to be able to manipulate a larger amount. Knowing how options work is essential if you are serious about understanding how the financial markets operate. That is why you should start by learning the basics of options trading. The last thing you need is to throw away your hard-earned money, right? Read on to gain a better understanding of this exciting investment practice.
What Are Options, Anyway?
An option is basically exactly what it says it is, an option to buy, or sell. There are option contracts available for almost every type of financial instrument such as bonds, shares, futures, and commodities. Each option is tied to another type of security called the underlying asset. For the purposes of this introduction, the focus will only be on equity options.
One equity option contract gives you the right, but not the obligation, to buy, or sell, one hundred shares of common stock in a company. Within the option contract is a predetermined price at which you can conclude this transactions called the strike price. There is also an expiry date on every option after which it is no longer valid. As a result, there is only one variable when dealing with an option contract which is the price, commonly referred to as the premium.
Types of Options
There are two types of options that you can buy. One is called a call option which gives you the opportunity to buy 100 shares of common stock. The second is a put option, which offers you the chance to sell the same amount. If you think that the value of the shares that you are looking to purchase the options on is going to rise, then you should buy a call option. Conversely, if you think prices are going to fall buy a put option. You do not have to exercise the right to buy, or sell the shares, unless the transaction will be profitable.
If you purchase an option, and it does not become profitable before the expiry date, then you will make a loss on the premium. The premium is the price you pay to purchase the option. When an option contract is ‘out of the money’ meaning that there is no profit to be made at that time, then the premium is usually quite low. As the price of the underlying share moves closer to the strike price of an option, the premium starts to rise, as the odds of it moving to being “in the money” i.e. profitable, increases. To key is to make wise moves. Fortunately, here is an expert online course that teaches you how to quickly become a smart option trader.
Practice With An Example Option Transaction
If you are interested in speculating on the share price movement of XYZ Company, but do not want to invest a lot of money in purchasing a block of shares, then buying an options contract could be the wisest move. If XYZ’s shares are currently trading at $12 and you think that the price is likely to rise over the next 3 months, then you can buy a 3 month call option. Because you expect the price of the shares to rise and you want to minimize your risk, you would look for a call option with a strike price that is higher than the current share price. This is because the premium will be lower as the call option contract is out of the money. For this example, there is a 3 month call option that has a strike price of $14 and a premium of 0.10. The premium is the cost per share of the option contract.
As the option contract is for 100 shares, you need to multiply the cost of the premium by one hundred, so the total cost will be $10. You now have the right but not the obligation to buy 100 shares of XYZ at $14 anytime in the next 3 months. If the price rises to $15 a share, then you can exercise you option to buy the shares at $14 for a total cost of $1,400, and sell them immediately on the market for $1,500. You profit will be $90 which is the total profit less the cost of the premium. Alternatively, you can just sell the option back to the market, as the premium will have increased to around $1 per share, to reflect the fact that the option is now in the money. It really does go back to having a system, doesn’t it? So how do you create one? This winning options trading system course will teach you all of that and more, on top of how to get lucrative returns on your investment.
To trade in options you will need to set up a brokerage account. Most online brokers can complete options transactions for you. Look for a broker that offers reasonable fees such as a discount broker. Make sure to check what kind of advice and information that the broker can offer you in return for their fees. For the most part, you should research sites before creating an account. This blog post lists five of the best stock trading sites gives you all of the background information you need!
Trading in options is risky as you can easily lose your entire premium if the price does not move in the direction that you are expecting. Do not trade in options with money that you cannot afford to lose as there is no inherent value in options contracts. Option trading can be a lot of fun, and the best advice is to trade with imaginary positions at first, and watch the markets to see if your strategy is working, before investing any of your actual money in speculating with options contracts. Once you have completed a few courses and practiced on your own, you will then be ready to unleash your unlimited trading potential!