There is usually a lot to talk about and learn before considering options trading. By taking options trading courses, you will learn strike prices, calls, puts, and premiums, among other things.
As a beginner, this may sound confusing, but things get clearer as you venture into the market. Therefore, the best way to venture into trading options is by taking the time to study and learn what goes on in this industry.
So, What is Options Trading?
It all starts here. You must know what options are before going into other things. This terminology is among the first you will learn in courses about options trading. They are comparable with stocks but are different. With stocks, you own a small portion of the company. This is called a share. As the company grows into the future, the share price increases. As a result, you can sell your shares at a profit.
For an option, this is usually a contract that allows an investor to buy or sell a stock or any other underlying security. This happens through a predetermined price within a set timeframe. However, you are under no obligation to buy or sell the stock when the date arrives. You can leave the contract to expire, and that makes it an “option.” However, investors pay a premium when buying options, which is money you will lose if the contract expires.
Types of Options contracts
Options are available for all types of securities. However, stock options are among the most common ones. In this context, there are two main contracts for options:
A call option gives the investor the right to buy the stock at a set price known as the strike price. This happens within a predetermined time called “expiration. Get options trading education to understand more about this investment.
For instance, assume a company’s stock is trading at $100 per share now. Then you may buy a call option to buy the stock at a strike price of $100 within six months before the contract expires, for a $10 premium price. Premiums are evaluated per share. Therefore, this call option would cost $1000 ($10 premium for 100 shares). However, remember that the strike price does not necessarily have to be the same as the current stock price.
If the stock prices remain the same or drop below $100 within the expiry period and do not recover, you can leave the contract to expire. Your total loss will be $1000 spent on premium and is the maximum value you may lose.
Suppose the price rises to $120. You may exercise your option to buy the 100 shares at the $100 strike price and sell them at $120. In this case, you would gain a $1000 return on investment. However, it would cost $10000 to buy the shares, but you would sell them for $12000 for a gain of $2000. Ultimately, you will have a net profit of $1000 after subtracting the $1000 premium value.
A put option gives an investor the right to sell a stock at an agreed strike price before it expires.
A put option serves the same purpose as shorting a stock. It will give you a profit should the stock price go down. However, put options can be used to hedge against drops in prices that could hurt your stock. Therefore, if the company stock price is $100 and you place a put option with a $100 strike price and a $10 premium for a six-month expiration period, the contract costs $1000 for 100 shares.
If the stock falls to $80, you can exercise your right to sell at the strike price of $100. In that case, you will not earn any profit, but the contract protects your shares from going down in value. If the stock price goes up, the contract will expire with no value, and you would be out up to $1000 maximum. Simply, put options work as stock insurance. This means that you can sell the options at a higher strike price. If the price rises, the paid premium is the fixed cost of the stock insurance.
After buying an options contract, several things can happen within the set timeframe. Here is what you need to know:
- You can exercise your option. Therefore, it means you will either buy or sell the stock shares at the agreed strike price. Take courses about options trading to learn more about this.
- You can sell the option contract to someone else.
- You can leave the contract to expire without any extra financial obligation on your part.
Why should you Trade Options?
You should be better positioned to understand why trading options are a viable option for investors like you with options trading education. However, here are a few insights as to why you should consider them:
- When you buy an option, it means you have control of more shares than when committing to stock shares with a similar amount of money.
- Options are a kind of leverage that provide expanded returns
- As an investor, you have time to see how things will turn out
- With an option, you have protection from downside risk since you can lock in the price without any obligation to buy
Important risk to know about options
Even though options are a great investment, you should be aware of the risks that exist. Part of your options trading education is to learn the setbacks that might arise after trading options:
- You can lose the investment entirely in a short period
- It is more complex than buying stocks, and therefore, you must be sure of what you are doing.
- You can lose more than what you invested if you take on certain types of options trade
To get the most out of options trading, it would help to take options trading courses. Find time to study and do due diligence before making any financial commitment to options trading. Use this guide to get started with this trade today!