CloseOption Knowledgebase

Introduction

Buying options might be a good idea when you want to move beyond stocks, mutual funds, or bonds in your portfolio. You have probably heard that trading options are complicated, or at least only for more sophisticated investors. The options can provide diversification but may also cost you unlimited money. The buying options offer a better starting point for the new investor, while selling options require more advanced investment strategies. But all in all, Options Trading For Dummies could be a good way of making profits.

Here, we will cover the basics of trading options contracts (calls and puts specifically) and cut through the investing jargon around options trading.

What Is Options Trading for Dummies?

The options business may be more complicated than it seems. So, precisely what’s options trading all about? If you are looking for a simple definition of options trading, it’s going to be like this:

Options trading gives you the right or obligation to purchase a particular asset at a specific price on that date. An option may be a contract attached to an asset, such as stock or other security. The option contract is suitable for a certain period, one day or several years.

You may sell your asset while purchasing an option, but you’re not required to do so. It is a matter of taking advantage of the opportunity if you decide to do so. You must fulfil the contract when you sell an option. Selling options is where things get more complicated, and you could risk losing an unlimited amount.

If you are a DIY trader diving into options via an independently managed investment account, you will be in total control of your trading decisions and transactions. That’s not to say, however, that you are alone. Many communities gather traders to discuss the current market situation and options trading strategies.

Different types of Options Trading

You can trade options with an online brokerage account that allows you to make your own trading decisions. It would be best to familiarize yourself with the various options you are permitted to deal with to form a knowledge base. Call and put options are the two most important categories of possibilities.

What is buying a put?

Put options are the opposite of call options. Instead of having the right to buy an underlying asset, a put option enables you to sell it at a fixed strike price (consider it as putting the underlying security away from you.) There are expiration dates for the options as well. If you can comply with them, the same style rules are valid in America and Europe.

Put options example

For example, at $50 per share with a premium of $1, you buy a put option for 100 shares of ABC stock. The stock’s price falls to $25 per share by the option’s expiry date. You can still sell 100 shares at a higher cost of $50, and your profits would be $25 x $100less the $1 premium you’d have paid if you exercised this option, amounting to $2,200.

On the flip side, you would be free of your premium and any commissions if the share’s price went up.

What is buying a call option?

A call option gives you the right to buy the underlying security at a specified price within a specified period, which you think of as calling the underlying security to you. The hit price is the price that you’re paying. An expiry date is the day on which the call option expires.

The US-style call option or European-style call can be used. You may purchase the base asset at any time up to its expiration with American-style options. Only purchasing an asset at the end of its life can be carried out through Europe-style options.

Call options example

The US-style call option or European-style call can be used. You may purchase the base asset at any time up to its expiration with American-style options. Only purchasing an asset at the end of its life can be carried out through Europe-style options.

In the meantime, the stock price is going up to $100. You’d be saving yourself $4,700$50x$100, minus the $3 per share premium if you used a Call Option Contract to purchase that stock at discounted prices. You would be out $3 per share in premium expenses if the stock price were to fall and an option contract ended.

How to trade options in simple steps

Consider the following steps to trade options:

  •  Open a trading account: When it comes to opening an options trading account, opening a brokerage account is different from opening an options trading account, especially if you plan to use a margin in your trading (borrowing money from your broker to trade). Option trading brokers may request your investment objectives, trading experience and skills, personal financial information, and types of options to change.
  •  Choose an option contract you want to trade: You can choose from a wide range of options contracts, so research different strategies and stocks and be aware of all the publicly available data before choosing your path.
  • Choose your strike price:  Buying an option only benefits if the stock price closes the option “in the money.” The strike price is the cost at which an underlying security’s acquisition or sale may take place in accordance with your options contract.
  • Make your trade:  Finally, pay the insurance premium, broker’s fees, and contract ownership.

Selling options contracts

For investors with expertise, selling options is a more advanced trading strategy. You can buy options or sell underlying securities, whereas you should honour the option contract if you sell them. Let’s take a look at the following example:

Let’s say you sell a call option to 100 shares of the stock ABC, currently worth $100 per share, for a $3 premium and $150 strike price. If the price goes down, the buyer will let the contract expire worthless, and you will keep the $3 per share premium, which is $300.

However, if the cost rises to $200 and the contract buyer purchases the call option, you are obligated to sell them the stock at the fixed strike price of $150 per share — but you would still have to purchase the shares at the new strike price of $200. While you still get to keep the capital of $300, you are at a net loss of $2,700 ($50 per share less than the premium). It is considered a strategy for more advanced traders because of the high risk involved in trading options.

How to read a stock option quote

For new option traders, options based on stocks that are more commonly called “stock options” serve as the natural starting point. For example, stock options are traded as quotes on exchanges such as the New York Stock Exchange. Before making your move, it is important that you understand the details of this stock option quote. Standard stock options prices and options trading terms are divided into five parts:

  • The stock symbol is used to identify the underlying asset attached to an options contract.
  • The expiration date is when the option contract expires, and the order will be invalid.
  • The strike price is the price at which you are allowed to purchase the option.
  • Type refers to the type of option position involved, i.e., call or put.
  • Premium is the price of buying the option’s contract itself.

How is options pricing determined?

Using two different models, you can calculate the option price. However, intrinsic and time value are at the heart of options trading prices.

The intrinsic value of an option is based on a difference in the strike price and the asset’s current valuation, representing its profit potential. How volatility affects an asset’s worth before it expires is considered in the time value.

The stock price, strike price, and expiry date can also affect options pricing. Their prices influence the intrinsic value of stocks and the strike price, while time values also affect expiry dates.

The Potential advantages and risks

Options trading makes a list of possible benefits and risks, which must be understood if we are to avoid making expensive errors. As far as advantages are concerned, options markets offer more flexibility and liquidity. You may invest with smaller amounts of capital than other investment opportunities. The option can protect you from downside risk and diversify your portfolio.

But buying a single stock, ETF, or bond can be much more risky than trading options. You need to be able to predict the stock price’s movement, and options trading can provide you with a severe and unlimited loss if your prediction of one security is wrong. Examining whether options trading will align with your overall objectives and risk tolerance is essential.

Options Trading for Dummies Cheat Sheet

You should check out more advanced options trading strategies once you have mastered the fundamental options trading concepts. You can incorporate traditional methods or techniques into your investment efforts as you get more comfortable with options trading. In the following, we have explained some most popular time-tested strategies which you can use as a cheat sheet if you are a beginner.

Covered calls

The cover call strategy has two parts: You’re buying an underlying asset. And you’ll sell the call option for this asset. Selling call options on your investments can provide you with profits if the stock does not exceed the strike price.

Married puts

A married put strategy is to buy a property and purchase options on an equal number of shares. This means you are protected from the downside by having the option of selling at a strike price.

Long straddle

In the long straddle strategies, a call option and put option shall be bought simultaneously for an equal asset with an identical strike price and expiry date. If an investor is still determining which direction the price of a given asset will be moving, you can use this approach.

Five things to know before you start options trading

If you are interested in options trading as a novice trader, consider these factors as you start.

  1.  The options are traded in several underlying securities:

It is essential to note that options may be attached to other types of securities, not stocks only, and we refer to all of them as a call position or a put position. Equities, indexes, and exchange-traded funds are the most common underlying securities in options trading. Several differences between the options produced by indexes versus those generated from equity or ETF funds are apparent. Before you begin trading, it is important to know the differences.

  1. Options trading is all about risk management:

If you’re in the wheelhouse of statistics and probability, chances are you’re also in the wheelhouse of volatility and trading possibilities. You only need two types of volatility, historical and implicit, to be concerned about as an individual trader. Historical fluctuations are a measure of the past and how much stock prices fluctuated daily for one year.

Implied volatility is based on what the market will “impede” with regard to future stock movement over time for an option contract. One of the most important concepts that options traders should be able to understand is implied volatility, as it can help you figure out whether a particular stock’s price will go up or down in time. This may also be an indication of the volatility of the market.

  1. Options trading lingo

In the course of trading options, you may purchase or exchange calls and puts. You are allowed to be tall or short in the market, but that does not affect your height! So you can also be the one who is At The, In The, or Out The Money. These are only a few commonly used words in this room of option traders. To make sure that the terminology is clear and concise, it pays to do so. This is why most brokers have developed a glossary of options trading to help you sort it all out.

  1. Options Traders Borrow Their Language from the Greeks

We want to talk about something other than Aphrodite or Zeus. In order to describe how options prices are expected to change on the market, which is important for successful options trading, traders use the Greek alphabet. Delta, gamma, and theta have been most commonly mentioned in options trading.

Although these handy Greeks help explain different factors that affect price movements in options, their values are theoretical as a function of the market’s expectations for an option to be changed. To put it another way, you can never be 100% certain that such forecasts are correct.

  1. You Should Clear Your Trading Goals Before You Start Options Trading

Like many investors, options traders should clearly understand their financial goals and the desired market position. Looking at and thinking about money significantly impacts how you deal with options. The best way to get your investment goals clear before you fund the account and begin trading on your own is to have a concrete plan for investing. If you are interested in using a free options trading demo account before you involve your real capital, click Here.

Conclusion

Now that you have understood what Options trading for dummies means and its reviews, you can step into the options trading market more confidently and make money through trading.

 

Resources:

https://www.goodreads.com
https://www.wiley.com

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