An option is a financial instrument that is very flexible and dynamic, which makes them ideal for short-term trading. Their flexibility allows investors to differentiate their investing techniques from traditional stock trading.
However, a solid executable strategy and investor foresight are needed to invest in options to make them lucrative and profitable because they can be highly tricky to understand at first.
This guide will let you discover common options, where they trade, and how you can use them to your advantage.
Let’s learn about options.
Essential Concepts To Understand Options
- Holder of options: The person who invests in options.
- Strike price: The agreed price (specific price) that will be used on exercising or utilizing the options in the future.
- Expiration date: The date at which options will get expired.
- Premium: A fee to get options.
What Are Common Options?
There are two common types of options:
Call Options
- Give the holder the right but not an obligation to buy shares at a predetermined price by a specified date.
- Can be utilized at a future date to earn a profit on the trade.
- Allows the holder of options to profit when the share price moves in its favor.
- Rewards can be high as you spend only the maximum strike price.
- The most you can lose is the premium paid when buying call options.
Put Options
- Give the holder the right to sell the shares at a predetermined price by a specified date.
- Protects the holder of the options from a potential loss.
- If the price of shares goes below in the future, the holder of the options can still sell the shares at a strike price.
- If the share price doesn’t fall as anticipated, the most you will lose is the premium paid, and your options will expire worthlessly.
If you think that the above investing strategies are overwhelming to understand, let’s simplify the concept of these options with the help of examples:
Example To Call Options
Let’s think that a listed company’s stock is trading at $100 per share on the stock exchange, and you want to buy 100 shares that will cost you $10,000 (100 x $100). When you look at the market patterns and analyze the situation, it is expected that this stock will be trading at greater than $130 two months from now which is very tempting. However, you do not have $10,000 to spend upfront.
So, as opposed to purchasing the shares today. You decide to go with a better and safer alternative, i.e., to buy call options with a strike price of $130 at an expiration date roughly two months from today by paying a premium of $300, which makes you eligible to buy 100 shares of that company at a future date.
After two months of investing in call options, the same share trades at $145 on the stock exchange. This is where your two-month-old wise decision will prove handy.
Since you have decided to buy call options with a strike price of $130, you can use your options to acquire 100 shares at $130 even though the current market value is $145.
This way, you can purchase, trade, and make a profit through 100 shares by getting them at your strike price, i.e., $130, and trading them at market price, i.e., $145.
Example To Put Options
Suppose you hold 100 shares of Company Z, whose current market price is $100 per share. There is significant uncertainty that the share price of Company Z will take a dip from $100 to $70 per share within two months due to the dire economic situation in the country.
Even though this uncertainty is prevailing in the market, you don’t want to sell your shares right now. To cover this risk, you buy a put option at a premium of $5 per share, which lets you sell your shares at the lowest of $80 in case the share price goes down within the next two months. After one month, the price per share drops to $70. Now, the put options will prove handy, saving $5 per share ($80 less $70 less the premium of $5). This is how investing in put options can minimize a potential loss.
Where Do Options Trade?
There are many exchanges worldwide where you can invest in options. However, the Chicago Board Options Exchange is the most preferred. It was founded in 1973, and more than 2,700 companies’ stocks trade on it.
The other significant alternative exchange is the NASDAQ Stock Exchange. This exchange was founded in 1971 and trades options on 4,000 multiple stocks.
There are also loads of smaller choices exchanges worldwide where you can discover alternative trading and begin producing revenue. Further, there are popular trading apps where you can invest in options. Two of the bests are highlighted below:
Tradestation
Tradestation is an excellent options trading platform that allows you to invest in options by paying a nominal fee.
Robinhood
Another platform to make profit trading options is Robinhood. You can trade options on stocks and ETFs on their platform.
Conclusion
You must comprehend how the system works and choose the most effective options trading technique. Options trading does not have to be difficult, yet you can shed cash if you are not mindful.
As a newbie, it is best to not go for risky options trading techniques and stick to straightforward ones like acquiring calls and getting in touch with stocks that have been performing well lately.