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What is Options Trading and How to Trade Options

What is Options Trading and How to Trade Options

Are you interested in skyrocketing profits in your trading account? Look no further; options trading could be an outstanding choice for making profits from market movements. In this article, you will learn what is options and how their strategies can work.

Understanding Options

Options is an agreement that gives the buyer the right, but not the obligation, to buy or sell a fundamental asset at a pre-fixed price and time. The fundamental asset can be a stock, index, commodity, or currency.

Options come in two kinds: calls and puts. A call option offers the buyer the right to buy the fundamental asset at the strike price before the option expiry date. A put option offers the buyer the right to sell the fundamental asset at the strike price before the option expiry date. The strike price is the price at which the purchaser can purchase or sell the fundamental asset.

How Do Options Work?

People might confused about the concept of options trading about how they work. For better understanding, we have distributed it into five main parts.

1. Based on Stock

Every option is based on assets; in most cases, that means stocks. However, an option usually represents 100 shares of a specific stock that the owner of the option can purchase or sell while the option is still active. It is called exercising the option.

2. Type of Option

There are two types of options available: either a call or a put.

3. Expiry Date of Option Contract

Every option contract comes with an expiry date, but the date could be from a few days to a few years from the time you purchase the option. You can purchase or sell the option based on or sell the option contract to somebody else who wants to purchase it up until the expiration date. However, when the expiration date comes and goes, the option vanishes.

4. Strike Price

If you select to exercise the option, the strike price is the price you will be able to sell or purchase each share of the stock that the option contract is based on. If you have a call option with a strike price of $50 and the stock’s price rises to $85 per share, you will still be able to buy at $50. It also makes your option contract much more worthy on the options market.

5. Cost of the Option (Premium)

Cost per share you need to pay for the option contract. You usually see an option listed for $10. But it is not truly worth $10. Keep in mind every option represents 100 shares of a specific stock. This $10 is the cost per share of the option. So, actually, you would multiply the cost of the option by 100 to get your premium; in that case the premium is $1000.

6. Types of Options Trading Strategies for Novices

The process can be more complicated than navigating traditional stock trading. It happens because investors jump into this without a real strategy in mind. The powerful key to success in options is learning the different ways to invest before approaching it. Mostly, investors try to learn and perform, and as a result, they get confused or portfolio losses.

The below-mentioned list guides you with some of today’s best options and strategies for novices:

1. Buying Calls Or Long Calls

Buying calls is an outstanding strategy for newbies and investors who are confident in the prices of a certain stock, ETF, or index. Long calls give the ability to investors to take benefit of rising stock prices, as long as they sell before the options expire. This type of strategy helps to reduce overall risk when trading options. The potential loss is only the cost-per-share (premium) paid to purchase the contract. However, the potential profit is unlimited depending on how much the price of the share is increased.

2. Buying Puts Or Long Puts

Buying puts is quite similar to buying calls, except investors assume the asset will decrease in value rather than increase. Traders typically utilize this strategy as a replacement for short-selling because the risk is smaller. When buying puts, traders are only risking the amount of premium if the asset crosses the initial strike price. Depending on the value of the premium, buying put can be a low-risk path to take benefit of falling prices.

3. Short Puts

The short put is a trading strategy for novices and investors who are selling options. The aim behind this strategy is to make a profit from the premium paid on options contracts. Suppose Investor A is executing a short put strategy and sells a put option to Investor B. If the value of those shares stays the same or increases, Investor B will definitely let the put contract expire. After the expiration of the contract, Investor A would keep the initial premium, thus profiting from the transaction.

4. Married Puts

The married put gets its name by combining two strategies of investment: stocks and options. These investments will be made concurrently, with investors purchasing one put option for every 100 shares of stock they purchase. If you remember from above, a put option hopes on share price decreasing. Therefore, in a married put, investors are attempting to make sure of themselves against a loss in share value. When implemented correctly, this strategy offsets portfolio losses while waiting for the prices of stock is increase.

5. Covered Calls

The covered calls strategy is made up of two options trading strategies. First, an investor must have fundamental stock in a company. Then, they must sell a call on the stock and get a premium. In a covered call, the investor is expecting that the stock price will be the same or slightly decrease. However, pushing the purchaser of the options to let their contract expire. In that way, the investor will keep the premium money they received. This strategy is common among investors expecting to generate income from stock ownership while the stock price remains the same or slightly changes.

6. Protective Puts

Investors usually use a protective put strategy to protect themselves from potential losses. Investors buy a long put against shares they already own, which protects them if the stock price is decreased.  The comparison between a protective vs. married put is that a protective put is used to reduce losses from shares you already own. On the other hand, married put protects shares you are purchasing simultaneously. This strategy is commonly utilized when investors are hoping for a short-term decrease in share prices.

Bottom Line

In this options trading guide, we have shared comprehensive details about options and their strategies. However, this trading is not for beginners; you need deep knowledge before you dive in.

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