Options trading looks difficult, but it is not that difficult once you understand Puts, calls, strike prices, premiums, etc. It is a trading instrument that gives us the right to buy or sell specific security on a specific date at a specific price.
Options contracts are valid for a specific period, which could be as little as a day or as long as a few years.
What Is An Option In Options trading
It’s easier to understand what options are by comparing them to stocks. When you buy stock, you are purchasing a share of that company this will make you a partial member-owner of the company. You believe the company will continue to grow and will give us profit in the future as its stock price will rise. If this occurs, you can sell the shares with profits.
An option is a contract that gives you the right to buy or sell a stock or other underlying security — usually in bundles like 100 — at a pre-determined price by a specific date. However, you are not obligated to buy or sell the stock when that date arrives. The name comes from the fact that you have the option of letting the contract expire. When buying options, however, you’ll pay a “premium” upfront, which you’ll lose if the contract isn’t renewed.
It’s important to note that options are available for a variety of securities, we will focus on the stock options.
There are two types of options contracts:
- Call option
- Put option
Call Option
A call option allows us the right to buy a company’s stock at a set price (known as the “strike price”) within a set time period (known as the “expiration”).
Put options
A put option allows us to sell a company’s stock at a pre-determined strike price before it expires.
In trading options, various things can happen like:
- You’ll buy or sell shares of the stock at the strike price if you exercise the option.
- Selling the contract to another investor/trader.
- Allow the contract to expire and you will be free of any financial obligations.
Benefits of Options Trading?
Options are used by investors/traders for a variety of reasons, but the following are the main benefits:
- It allows you to buy more shares at the same single stock price.
- Options are a type of leverage that allows you to get a bigger return.
- An option allows an investor/trader to wait and see how things develop.
- There are various strategies that can help us to play safe like long straddle strategy, short straddle strategy, etc.
What, on the other hand, are the dangers?
- You can lose your all investment in a short time.
- It is difficult to buy and sell premium as compared to buying stocks.
- It’s possible to lose more than your initial investment in certain types of options trades.
- With some leveraged options we can also lose more money than our initial investment.
Also read
9 Great Things About Stock Options