Getting Acquainted With Options Trading

What is Stock Options Trading?

Options trading is very different from stock trading because options have distinct characteristics from stocks. Investors should take the time to understand terminology and concepts involved in options before trading them.

Options are financial derivatives, meaning they derive their value from the underlying security or stock. Options give the buyer the right, but not the obligation, to buy or sell the underlying stock at a predetermined price.

Key points to remember

  • Options give a buyer the right, but not the obligation, to buy (call) or sell (put) the underlying stock at a predefined price called the strike price.
  • Options have a cost associated with them, called a premium, and an expiration date.
  • A call option is profitable when the strike price is lower than the market price of the stock since the trader can buy the stock at a lower price.
  • A put option is profitable when the strike price is higher than the market price of the stock since the trader can sell the stock at a higher price.

Understanding Stock Options Trading

Trading options is more like betting on horses at the racetrack: everyone is betting against everyone else. The track just takes a small cut to provide the facilities. So trading options, like racetrack betting, is a zero-sum game. The option buyer’s gain is the option seller’s loss and vice versa.

An important difference between stocks and options is that stocks give you a small piece of ownership in a company, while options are just contracts that give you the right to buy or sell the stock at a certain price. specific to a specific date.

It is important to remember that there are always two sides to every option trade: a buyer and a seller. In other words, for every option bought, there is always someone else selling it.

Types of options

The two types of options are calls and puts. When you buy a call optionyou have the right, but not the obligation, to buy a stock at a fixed price, called the exercise price, at any time before the option expires. When you buy a put optionyou have the right, but not the obligation, to sell a share at the strike price at any time before the expiration date.

When individuals sell options, they are effectively creating security that did not exist before. This is known as writing an option, and explains one of the main sources of options since neither the associated company nor the options exchange issues the options.

When you write a call, you may be forced to sell shares at the strike price any time before the expiration date. When you write a put option, you may be obligated to buy shares at the strike price any time before expiration.

There are also two basic styles of options: American and European. An American option can be exercised at any time between the purchase date and the expiration date. A European style option can only be exercised on the expiration date. Most exchange-traded options are American-style, and all stock options are American-style. Many index options are European style.

Option pricing

The price of an option is called the prime. The buyer of an option cannot lose more than the initial premium paid for the contract, no matter what happens to the underlying Security. Thus, the risk for the buyer is never greater than the amount paid for the option. The profit potential, on the other hand, is theoretically unlimited.

In return for the premium received from the buyer, the seller of an option assumes the risk of having to deliver (if a call option) or take delivery (if a put option) of the shares of the stock. Unless that option is covered by another option or a position in the underlying stock, the seller’s loss can be unlimited, which means the seller can lose significantly more than the initial premium received.

Please note that options are not available at any price. Stock options are typically traded with strike prices at $0.50 or $1 intervals, but can also be at $2.50 and $5 intervals for higher priced stocks. Also, only strike prices within a reasonable range around the current stock price are usually traded. Far in or out of the money options may not be available.

Profitability of options

When the strike price of a call option is higher than the current stock price, the call is not profitable or out of the money. In other words, an investor is not going to buy a stock at a higher price (the strike price) than the current market price of the stock. When the call option strike price is lower than the stock price, it is considered in the money since the investor can buy the stock at a lower price than the current market price.

Put options are the exact opposite. They are considered out-of-the-money when the strike price is lower than the stock price, because an investor would not sell the stock at a lower price (the strike price) than the market price. Put options are in-the-money when the strike price is higher than the stock price, because investors can sell the stock at a higher (strike) price than the stock’s market price.

Expiry dates

All stock options expire on a certain date, called expiration date. For normal listed options, this can be up to nine months from the date the options are first listed for trading. Longer-term option contracts, called long-term equity anticipation securities (LEAPS), are also available on many stocks. These can have expiration dates of up to three years from the date of registration.

Options expire at market close on Friday, unless they fall on a holiday, in which case the expiration is pushed back by one business day. Monthly options expire on the third Friday of the expiry month, while weekly options expire on every other Friday of the month.

Unlike stocks, which have a two-day settlement period, options settle the next day. To set the expiration date, you must exercise or trade the option before the end of the day on Friday.

Stock Options Trading FAQs

What is a stock option contract?

A stock option contract entitles the owner of the contract to 100 shares of the underlying stock at expiration. So if you buy seven call option contracts, you acquire the right to buy 700 shares. And, if the owner of a call option decides to exercise his right to buy the stock at a given price, the option writer must deliver the stock at that price.

What do stock options cost?

Options contracts typically represent 100 shares of the underlying security, and the buyer will pay a premium for each contract. For example, if an option has a premium of $0.55 per contract, buying an option would cost $55 ($0.55 x 100 = $55).

How do you make money trading options?

You can earn money by being a option buyer or seller of options. If you are a call option buyer, you can make a profit if the underlying stock goes above the strike price before the expiration date. If you are a put option buyer, you can make a profit if the price falls below the strike price before the expiration date.

Is options trading better than stocks?

Options trading can be riskier than stock trading. However, when done correctly, it can be more profitable for the investor than traditional stock market investing.

Disclaimer: Curated and re-published here. We do not claim anything as we translated and re-published using Google translator. All ideas and images shared only for information purpose only. Ideas and information collected through Google re-written in accordance with guidelines and published. We strictly follow Google Webmaster guidelines. You can reach us @ chiefadmin@tipsclear.com. We resolve the issues within hour to keep the work on top priority.

See also  RSVP Now: How to Create a New Product Category with Miguel Garza ​​​​​​of Siete Family Foods, a Stream Event Today at 1 p.m. ET