Options Trading
Options are basically contracts between two parties that give holders the right of buying or selling an underlying asset at a specified price within a set time.
Options are securities that can be subject to binding contracts just like futures and stocks. Options and futures contracts are different in that you can buy or sell underlying securities or assets without being bound to do so as long as the rules of the options contract are followed.
Options can also be called derivatives. A derivative is a financial instrument whose value is not determined by its intrinsic worth but by the value of its underlying security. For example, options on IBM stock are directly affected by the stock’s price.
Type of Options
Options come in two forms: calls and puts. Adding them to your existing investing and trading tools will allow you to take advantage of both bullish or bearish movements in any underlying asset. This can be done to reduce your total risk or protect an existing position.
Options are different from stocks in the way they’re made and what they represent. This distinction results in trading rules and other decision-making criteria that go beyond the simple buy/sell considerations.
Call Options
You have the right to purchase a stock at a specified price by the date you hold a call. The call option can gain value if its underlying stock rises. This is why the call price will go up when the stock prices go up. However, if the stock price moves too late, the call could be canceled. Because the stock’s value is rising, a call option allows you to invest less and still receive an increase in its value.
Put Options
You have the right as a put owner to sell stock at a certain price and by a particular date. Although a put option can gain value when the stock price falls, it must be done before the option contract expires. A stock option that you have for the long-term increases in value during downturns.
Contracts have a limited lifespan so you must exercise your rights within a specified time. Time risk is the primary danger associated with options. Options have expiration dates that range from 9 months to 2 years. Options trading requires the ability to select options that have expiration dates that allow for anticipated moves.
To avoid confusing your call and put rights, you might consider calling the stock away (buying) or putting it to someone else (selling).
Option Risks
Both put and call options carry risk, but this is only limited by the initial investment. Although the initial investment may vary in size, it is still less than the required investment to hold the same number of shares of the underlying stock.
Although the risk of an option expiring is lower in dollars, it is still important to understand that the probability of the option ending up zero is greater than the possibility of the underlying stock ending up zero. Because an option expires, there is a 100 percent chance it will become null. The option value is zero upon expiration.
Call Option Risk
As expiration nears, the strike price of the call option falls below that of the underlying stock. An option’s cost less its intrinsic value, or the difference between its strike price and that of the underlying stock, is its time value. If the stock is at the same price, time decay can cause losses, but these losses are minimal because the option retains its intrinsic value.
The option’s value will be an all-time value if the stock trades below the strike price. If the stock is trading at the same price, the time value decreases as you approach expiration. Continued in this fashion will result in a total loss of the original investment.
Stocks don’t always move in a straight line. They fluctuate. You could see your entire investment disappear as the expiration date nears.
Understanding option valuations is important to ensure you don’t overpay for any remaining options. This time risk can be managed by exiting long options at least 30 days prior to expiration. The option’s value will decrease at an increased rate within 30 days.
Put Option Risk
As expiration nears, a put option loses its time value. This can lead to losses for traders if the stock trades above the strike price. The option retains its intrinsic value, so losses when trading below the strike price are minimal.
The option’s value will be an all-time value if the stock trades above the strike price. If the stock is trading at the same price, the time value decreases as you approach expiration. Continued in this fashion will result in a total loss of the original investment.
The stock has the same chance to rise as it falls, so there is a possibility that the underlying stock will appreciate in value and surpass a put strike price. As a result, you can lose your entire investment as expiration nears.
Trading Between Futures and Options
Futures traders are risk-takers by nature. They can survive the first stages of pain and endure the disorienting down periods. Options are an integral part of the trading game that futures traders play. However, it is worth noting that both options and futures can be used as standalone trading vehicles. Are you a trader in options or futures? These questions will help you answer this question:
How much do you have in cash?
Expert traders will tell you that $100,000 is the minimum capital required to start trading. However, many successful traders started with much less than $100,000 and have gone on to make a fortune.
It would be foolish to mislead you by giving the impression that your chances of success are high if you begin trading with very little capital. If you don’t have enough money or are unsure how to proceed, it is a good idea to reconsider trading, create a solid trading plan, and follow its guidelines.
How involved do you feel?
Futures and options trading is a risky business that requires active participation. You must keep up to date with world news through television and the internet. This doesn’t just mean that you can only pick up what is on the news headlines or evening news. Your trading skills must also be developed by continually reviewing and changing your strategies and plans.
Do you have the technology?
A computer system that has enough memory and is fast will allow you to view large amounts of data, run multiple browsers simultaneously, or use more than one monitor at once. A high-speed Internet connection is also necessary. You will also need to have two high-speed Internet connections if you are serious about trading.