Conventional wisdom tells us to place our money on an investment vehicle we are most familiar with and on investment vehicle we can benefit most. Since understanding the rise and fall of stocks is much easier than knowing the basics of options trading, it is a more popular choice for the many. But the fact is options trading provide several advantages than any other investment vehicles, including the stock market or even the Forex. Let us look at some:

Leverage

Buying a call option gives the investor a good option position that is similar to stock position. For example, if an investor would by 300 stocks selling at $50 per share, he would have to pay $15,000. But if he would choose to purchase three $20 calls (each contract representing 100 lots or shares), he will only have to pay $6,000 (3 contracts X 100 shares/contract X $20 market price). The investor would then have an extra $9,000 to spend or invest on his or her discretion. The process is obviously not as simple as that. The investor would have to know which call to buy to have a good option position, similar to stock position. However, if you are looking for a good investment without risking large sum of money at once, option trading is the better choice.

Limited Risk

Investment is said to be for the risk takers. This is good if your risk automatically yields to profit. But that is not always the case. In options trading, however, you can have unlimited profit potential and at the same time have limited risk. This is because options trading only give you the right to buy or sell underlying asset, and not the obligation. Meaning, if the price is not right at the end of the contract, you can just ignore and let the contract expire. If, however, you can profit for the change in shares prices, you can assert your right and pursue the contract.

For example, you buy a certain call option for $20 (strike price) that will end on the third Friday of March. On the expiry date, shares you bought are trading at $25. Definitely, you can instantly earn $5 per share and would have to pursue with the contract.

What if the at the expiry date is lower than the strike price?

Let us imagine that the shares you have bought went down to $15 or even $5 at the end of the contract, do you have to pursue the contract? No!

You just have to let the contract expire.

What have you lost then?

The option premium you paid the seller. Nothing more.

Unlimited Profit Potential

Say a certain call option you have bought is now trading at $38 per share. You can exercise your right to buy it for the strike price of $20 and earn $18 minus the Option Premium you have paid. This is just an example. The price of shares can go higher than that. And if you have carefully chosen your call, you can get the best profit without breaking your bank. Note: if you are planning to pursue the contract and buy the shares, remember that you have to pay the full amount. So at the expiry date, make sure that you have you the cash.

For individuals who are after running their own enterprise and saying goodbye to their regular job, putting up a business online is one option. Sure enough, you have already heard about options trading. It is one of the hottest endeavors today since such venture promises better rewards to the investors. What must you know about it then? How can you turn yourself into a successful trader? What are the rules, strategies, and fundamentals that you must absorb? Are there other definite strategies that you have to adopt and utilize? These are simply among the questions that you should find answers to. Better yet, read on and grasp a great deal of information about this trendy enterprising undertaking.

Options Trading Simplified

As it goes, this type of trading points out to an investor who is determined to trade a certain stock at a higher or lower price within a specified time frame. The trader is then able to appoint the high or low price. Changes can thus be made in the prices especially when the market proves to be unstable. At the same time, higher prices can be assigned when the market is seen to be doing well. Since there is a targeted span of time for the expiration of the stocks, the investor is allowed to splurge into opportunities that entertain flexibility particularly in line with the predetermined outcomes of the market.

Take for example the following figures. In the United States of America, one option refers to about a hundred underlying shares. Meanwhile in Australia, the single option covers multiples of about a thousand of underlying shares. Since the trading is supposed to be done within a short time period, there are higher chances of collecting huge returns. On the other hand, just as when the market is unstable, the very nature of this trading likewise opens up probabilities of larger loss.

Explaining the Nature of Trading

The options can either be traded in groups of similar stocks or in singles. Here is the catch. The trading of single stocks is able to actually create higher risks of volatility because a single firm may be pursued by a variety of factors. Meanwhile, by trading in groups, the volatility is removed. In the end, the group itself ends up being rewarded.

More than investing a certain amount of money and taking intelligent guesses regarding the status of the trading market, you are also required to be familiar with the rules and standards of trading. You need tools to help you out in determining the existing market trends. You have to be equipped with a solid set of guidelines that will surely protect your investment. Even when there are materials that will show you how to do it, it still matters that you learn the ideologies by heart and execute them as you conclude the transactions.

Conclusion

More than ever, options trading is yet another rewarding opportunity that can enrich your financial standing. It is an occasion that allows the generation of profit in line with the investment made. There are a couple of techniques to apply so you should get the hang of it. Hard work, patience, and lots of efforts are all you need to exercise. After all, this is an undertaking that calls for your will to work.

It is easy to dismiss the benefits of a trade if the most typical description attached to it is risk. But it should not be so. There are great benefits that may be taken from participating in options trading that most people overlook. One should take into account that all types of trades have inherent risks but they also offer advantages in return.

Flexibility

Although it is true that options trading may not fit everyone, it still does not change the fact that to those traders who have made this trade work for them, it is clear for them that options offer great flexibility for both the option buyer and the seller.

Most types of trading do not allow profiting from the underlying asset. However, with option trading this is very possible. There are various strategies traders use to maximize this advantage.

Protection

In comparison to other kinds of trades, particularly stock trading, options trading could give better protection to its participants. Significant losses are typically uncommon in this trade since traders only lose what they have invested and more often than not, investments are just minimal because they are limited only to the price of the option. It should be noted that typical options are just 10% of the value of the asset.

Traders could also benefit from protective put. This is a type of options strategy that allows for purchasing the same number of puts and stocks such that the stocks are protected from depreciation of value. Also, a trader who needs to buy an option in the future at a certain price can do so. It is, in a way, insurance for the trader who currently has investments on long stock positions, especially during the times when the market is uncertain.

Leverage

Since the trader bought the “option” and not the stock, he could profit with very little investment. By coughing a small amount, the trader can control the full value of the stock because he holds a contract that performs in the same way the stock performs but for only a fraction of the stock price. This is probably the main reason why option trading is very appealing to traders with small funds.

Limited Risks

The limitations of risks can be seen from two perspectives. First, is from the duration or the period of the option and second, is from paying a minimum amount for the full value of the asset. During the period of the options, the holder can either exercise the option or not. Any unnecessary movement in the market may be prevented, thus giving more protection to the holder. On the other hand, if the option is not profitable, the holder will only endure the losses for a short and definite period of time.

Volatility Trading

Most trades only offer upwards and downwards movement. With this kind of trading, the participant may trade even when the market is dormant.

On a final note, by working within the principle of option trading, the trader has the liberty to buy or not to buy an option depending on the movement. That, in itself, is a great benefit since the trader is not obligated to pursue with the purchase of an asset even when he has already lost interest on it. The only thing one can lose is the payment for the option, which significantly costs lesser when compared with the price of the actual stock.

Understanding the components of option trading clearly outlines how much advantage a trader has. Without a doubt, people who have sufficient knowledge of a certain trade have better chances of profiting from it. In the same way, a trader who is knowledgeable in options trading has better control of his profits. In this article, three basic concepts will be presented. Let it be noted that the information covered here are intended for neophytes in options trading.

What is option trading?

Option trading is a category of trading stocks, bonds or any type of assets that acts more like a contract, which allows for liberty to buy or sell the asset but does not necessarily oblige the holder to exercise his powers within a certain period of time. In layman term, it simply means “buying” the right to buy or to sell an asset within a specified duration. It should be noted that buying the option is very different from buying the stock itself.

What are the types of options?

There are two types of options: the calls and the puts. Both of them work in exactly opposite principles.

The calls are options that provide the right for a holder to buy a certain asset at a specific price, during a specific period. This investment will be profitable only if the stock would increase during the period of the option. Calls are also oftentimes considered long positions.

The puts, on the other hand, are options that provide a holder to sell the asset at a certain price, within a specific period. This will yield profit for the holder if the stock price will depreciate during the period. Conversely, puts are often seen as short positions.

What are the styles of option trading?

There are two: the American Style Options and the European Style options. The difference between the two lies on the date when the option can be exercised. In European Style, options can only be exercised after the expiration date. American style option, on the other hand, provides more leeway as it allows the option to be exercised from the day of purchase until the day it expires.

Most stock traders hold the common misconception that the style of options depends largely on the geographical location where the trade was made. Wrong. Actually, the names American and European styles are just terminologies to separate one style from the other. It does not necessarily mean that when one trades in Europe, the trading style adopted is automatically a European Style or vice versa.

Who are the Buyers and Sellers in Option Trading?

These two types of options then lead to four different types of traders namely, the buyers and sellers of the calls, and the buyers and the sellers of the puts.

But, buyers and sellers of options are further distinguished by their general names: buyers are called holders and sellers are called writers.

Buying and selling of options comprise a very complicated scheme of trade. For the holders of calls a puts, an options contract does not oblige them to participate in the trade through either buying or selling. They have, at their disposal, their rights to either maintain an asset or to dispose it.

However, for writers of calls and puts, the contract necessitates that they either buy or sell an asset.

Option trading is by nature, a speculative type of trade. In trading-speak, it suggests that this kind of trading best suits those who seek risks and enjoy taking them.

Perhaps among the most complicated and possibly the riskiest type of trading is option trading. Most seasoned traders realize that option trading does not suit all traders. It selects its own type of people, usually the risk takers. And the trade itself requires skills and thinking unique only to people who could handle extreme risks. Most experts recommend this type of trading only to those people who have sufficient risk capital as it carries with it substantial risks.

By nature, it is also speculative. So if you are a person who doesn’t want to speculate too much, you might as well find another type of security which will work best for you. However, rejecting the idea of entering this trade right away is as risky as not knowing anything about it. It carries with it risks, that’s true, but it is also a highly profitable venture. You might as well try to learn something on it such that you could decide whether to try you luck on options trading or not.

While it is inherently risky, option trading also offers advantages that may not be had with other types of trades. Among its premium advantages is the flexibility it lends its investors. Each lender has the option to trade at a specific price within a predetermined period.

It is also, by comparison, a more advantageous type of trade because of the high leverage it offers. Depending on the location, each option may cover a number of underlying assets. In the United States, for example, each option may represent for 100 underlying assets. Thus, this principle lends the holder the capacity to profit from several assets within a single option.

So what is an option?

An option is a type of security, perhaps closely comparable to bonds and stocks. It is, in itself, a binding contract, that is monitored by and through strict terms and conditions. In gist, options are contracts that owners could buy or sell at a certain price prior to or on a specific date. An option is typically an added price tag to a certain asset or item because it is a reservation for the purchase or sale of a certain asset.

Options are also sometimes called derivatives. This is due to the fact that the value of an option is derived from the value of the underlying asset.

To give light on this topic, consider the example below:

Say you have considered buying a real estate property which is worth several hundred thousand dollars. However, when you first negotiated with the owner, you did not have sufficient money to purchase the property right there and then. So you made a deal with the owner to pay an extra $5, 000 to reserve the deal for you for the duration of two months. The extra money you put in is called the options. In case you don’t want to pursue with the sale, the owner of the real estate can neither force you to buy the property nor can the law impose the sale on you. However, you would still have to pay the price of the option.

In summary, when considering buying a property with an enclosed option, you will have the right to pursue with the sale or to turn down the sale. You are not obligated to do either of the two. However, you may lose 100% of your total investment in options trading which is the value of the option itself.

An option contract is an agreement wherein the owner has the right to buy or sell a security or an asset at a particular price on a fixed date in the future. It is called an option because the owner of the contract is not committed to carry out the obligation of the contract if he or she feels that it is disadvantageous.

There are two types of options contracts: call options and put options.

Call Options

In simple terms, call options give the owner the right to buy the underlying asset in the contract. Again, it is not an obligation.

For example, John and Tom agreed on a call options contract wherein John will buy from Tom, 100 shares (equivalent to one option) of Company A at $20 (strike price) what will expire on the third Friday of April. The current price of the share is $20.

At the expiry date (also called maturity date), the share price of Company A remains at $25. John can then exercise his right to buy the share for $20 and thus, yielding $5. Meanwhile, if the share price goes down to $22, John can still earn $2 by simply exercising his rights as stated in the contract. In whichever way, any amount higher than the strike price at the end of the contract will become the profit of the owner. But before it can happen, the owner who decides to pursue his right has to have his money ready to pay for the amount.

However, if the share price goes down below $20, say $18, on the maturity date, it will be too expensive for John so he can just ignore the contract since he is not obliged to carry it out. He will only lose the amount he paid for the contract called the Option Premium. Tom, on the other hand will keep the asset and the premium, which in a sense, is his profit.

Put Options

In put options, the buyer has the right to sell an asset to the writer (the seller). Just like the call asset, it is bounded by a contract which states that the underlying asset will be sold at a particular price and a particular date. But the similarity ends there. In put options, the writer has to buy the underlying asset at the strike price if the buyer exercises this option.

Let us continue with John and Tom. John bought call options from Tom. But he could also buy put options from Tom. If John buys put options, it means that he buys the right to sell Company A’s shares at $20 on April 1. If the price of shares goes down below $20 on the expiry date, John can exercise his right and can still sell it at $20, thus making a profit.

Buying put option allows investors to earn when price of shares drops at the end of the contract.

Profit potentials are unlimited for the buyers of put options, especially if the market begins to sell off. On the other hand, risks are limited if the market goes against them.

Important note:

In reality, trading of options or transactions does not happen between two persons. Buying or selling can happen without knowing the identity of the other party.

Options are only sold in 100 share lots. So if the share price is $20, you will have to pay $2,000 for each option contract plus the Option Premium.