Talk about risks. One of the notable things that most people would commonly say about option trading, or other types of trading for that matter, is that it entails risks. A lot of them. Some of them are discussed in this article.

First off, any trade, in fact almost anything that promises much profit surely carries with it lots of disadvantages. You only get what you pay for. As they say, you don’t get free rides. When you give more then you would most likely get more. The same principle works with the trade. With higher promise of profit come higher and greater risks to be taken.

So what makes option trading a high risk venture? It’s definitely the leverage. Leverage, in trade speak, is one of those crucial things that could make or break your trade. It gives you the advantage while taking away your potential profit if you pick the wrong option or the wrong timing to trade. Leverage is so attractive that it is among the things that make people want to enter trading but it is also disadvantageous when not properly used. In the case of options trading, there is higher leverage offered. Depending on which side of the coin you look, leverage could either mean boon or doom.

As defined in its financial sense, leverage is a relatively small amount of money you invest in something that could turn out big. Sounds pretty interesting but what’s the problem? Just like what was mentioned earlier, a higher leverage could mean higher loss of profits if the trade is mishandled.

Apart from these, risks of options trading can be seen from two different perspectives—the buyer’s risks, the seller’s risks.

Buyer’s risks

Options trading offer the possibility of losing your entire investment in a relatively short period of time. It is noteworthy that the main essence of options trading is to control a certain asset within a certain period of time at a fraction of the asset’s original price. So if you bought an asset that has an expiration of 3 months and within those months the stock remains at a certain price lower than what is profitable, then you could really lose all your investments very fast. Losses compound as the expiration date approaches.

This is the main reason why traders who are interested in this type of trading are advised to participate only with their risk capital.

Further, European style option, a classification of options trading, restricts its traders to exercising the option after the expiration date since it does not offer secondary markets. Also, there are certain option contracts that may further create risks as well as regulatory agencies that could limit the possibility of realizing the value of a certain option.

Seller’s risks

Option trading is also risky for the sellers. There are types of options that may have unlimited possibility of losses depending on the movement of the underlying stock. There are also occasions when even if there are no trading markets, sellers are obligated to sell options.

All the risks involved in options trading should be understood as something inherent to it. But any trader should not take the risks as the hook, line and sinker of the trade. As we have mentioned earlier, more risks mean better profits. So you should put into your calculation the risks but you must not forget the profit you could get from option trading.

Trading, in general, is a highly technical field that does not only require would-be participants to have some understanding on what a particular trade is or how it works but also in-depth knowledge of what goes within a particular trade. In short, basic knowledge is not as helpful as most think it is. Specialized trading types, such as that of options trading, may force its participants to gain more knowledge.

Here are some tips that could help power you up when starting with options trading:

Know the lingo. Option trading has its own jargon that may seem gibberish to people who do not know a thing about the trade. To them, the terminologies commonly used in trading, regardless of the form, seem so complicated that they would lose interest on the trade even before they get started. Well the lingo of options trading is downright complicated, probably contributing to why too few people involve themselves to it. However, once a trader manages to pick up some basic terms and has learned quite a bit about the trade, it would be much easier to understand how the whole thing works. Probably not all the ins and outs of the trade but the general idea would be well-understood. So do yourself a favor, study the terminologies commonly used in options trading and maybe after that, read a few stuffs about it.

Attend options trading seminars, online or off line. If you want the shortcut to learning the trade, you might want to consider attending seminars or subscribing to online seminars and tutorials. In most cases, seminars cover all levels of knowledge regarding the trade. So for beginners, it would be best to start with the basics of the trade and continuously improve your knowledge by completing a series of seminars.

Subscribe to online tutorials. There are several websites and companies that offer online tutorials which may consist of interactive modules, probably among the best learning tool there is. Interactive modules allow you to learn by practice.

Indulge yourself to some options trading books. Internet could provide the basic things you need to get started with options trading but you must realize that internet can only give you so much. If you have started researching online about this trade, you will find out that the websites dedicated on options trading and other kinds of trades only cover the same things- basics of the trade, common terminologies, some risks involved and others. If you want thorough discussions on the trade, you have to rely on books written by well-recognized authors. Remember the operating word- well recognized. There may be a number of books written on this subject but you must try to pick the best book available so you don’t have to waste your time on repetitive information that you could commonly find online and rubbish talk that may not help you at all.

Once you have read a comprehensive book that discusses on various areas of options trading, it would be much easier to understand technical analysis. At this point, you will have to analyze what the charts suggest, know the types of options that you may want to trade (there are lots of them so be sure to pick out the one that suits you best), use the options strategies that work well with you, and demonstrate knowledge on various market analysis tools.

Although there are hundreds of terms that are used in the financial language, beginners have to understand first the most important and commonly used words.

Option – is the right of the buyer to either buy or sell the underlying asset at a fixed price and a fixed date. At the end of the contract, the owner can exercise to either buy or sell the option at the strike price. The owner has the right to pursue the contract but he or she is not obligated to do so.

Call option – gives the owner the right to buy the underlying asset.

Put Option – gives the owner the right to sell the underlying asset.

Exercise – is the action where the owner can choose to buy (if call option) or sell (if put option) the underlying asset or, to ignore the contract. If the owner chooses to pursue the contract, he must send an exercise notice to the seller.

Expiration – is the date where the contract ends. After the expiration and the owner does not exercise his or her rights, the contract is terminated.

In-the-money – is an option with an intrinsic value. The call option is in-the-money if the underlying asset is higher than the strike price. The put option is in-the-money if the underlying asset is lower than the strike price.

Out-of-the-money – is an option with no intrinsic value. The call option is out-of-the-money if the trading price is lower than the strike price. The put option is out-of-the-money if the trading price is higher than the strike price.

Offsetting – is an act by which the owner of the option exercises his right to buy or sell the underlying asset before the end of the contract. This is done if the owner feels that the profitability of the stock has reached its peak within the date of the contract.

(Option seller) Writer – is the seller of the underlying asset or the option.

Option buyer – is the person who acquires the rights to convey the option.

Strike Price – is the price at which the underlying stock must be sold or purchased if the contract is exercised. The strike price is clearly stated in the contract. For the buyer of the option to make a profit, the strike price must be lower than the current trading price of the stock. For example, if the contract states that the strike price of a certain stock is $20 and the current trading price at the end of the contract is $25, the buyer can exercise his or her rights to pursue the contract, thus earning $5 per stock.

Option Premium – is the amount of the contract which must be paid by the buyer to the writer (the seller). The amount of the option premium is determined by several factors such as the type of the option (call or put), the strike price of the current option, the volatility of the stock, the time remaining until expiration and the price of the underlying asset to date. Taking into account these factors, the total amount of the option premium is number of option contracts, multiplied by contract multiplier. So if you are buying 1 option contract (equivalent to 100 share lots) at $2.5 per share, you must pay a total amount of $250 as the option premium (1 option contract x 100 shares x $2.5 per share = $250).