An option is a contract, which offers you a chance to sell or buy an underlying asset at a specific time for a prearranged time. An option has an expiry date and definite terms like any other agreement. The key difference in buying an option rather than stock is the leverage traders get.
A small capital amount is necessary to gain potential for large rewards. You will need to predict the underlying assets price direction correctly or else your whole investment will be at risk. The investment is at a fraction that what it would be to buy a stock outright.
When you trade options there are some things you need to know…….
- If you decide to buy an underlying asset then you intend to purchase it at a low price.
- If you decide to sell an underlying asset then you intend to sell it at a high price.
- If the underlying asset us not bought or sold before the expiration date, the options contract becomes invalid.
- One option contract = 100 shares of the underlying asset.
- Full price is not paid but a premium is paid as upfront.
Before trading options as a new investor, it is wise to take help from options trading service. You must understand leverage, option strategies, exit plan needs, risk management, portfolio diversification, and more.
Before you trade consider some things……
- Predict the movement of the underlying stock price – upwards or downwards?
- Estimate how much will the price change. It helps to determine the contract worth buying – put or call. For put, the strike price has to be higher than the current market price. For the call option, the strike rate has to be less than the existing market price.
- Choose the expiration date after predicting the time it will take for the value to hit your estimated strike price.
Expiry dates range from weeks to years. New traders must stick to long term expiry dates. The stock price gets space to move.
Benefits of options
- The small upfront investment is needed
- Gives time to figure out action plans
- You get a chance to profit if you want [use it or not]
- Helps to hedge and control losses
Drawbacks of option trading
- Beginners can find it overwhelming
- An option contract has limited worth
- Brokers are fussy in allowing comprehensive trade options
Options trading vocabulary
Call – You can buy the stock in the future at price defined in the contract.
Put – You can sell the stock in the future at the price mentioned in the contract.
Strike price – The specific price an underlying asset gets bought or sold while executing the options contract.
Premium – It is the upfront price paid for the options contract on a per-share basis. For example, if the cost of an underlying option is $3 then for 100 shares its cost is $300
Expiration date – It is the last day when you can sell or buy the underlying asset. The contract becomes worthless after this date.
How an option’s value gets calculated?
Intrinsic value – It is the difference between the strike price and the call/put price of the underlying asset.
Time value – Longer the expiration date means higher the time value of the contract. For example, a 5-month options contract has a high time value than 1 month.
Start getting educated on options trading at Steady Options, an online advisory service. You can gain access to the vast resource as well as a forum where seasoned traders share their skills.