What is Options Trading?
Options trading is a big world! To many beginners, the term may sound intimidating or risky, but studying basic strategies may help a novice investor hedge market risk. Due to the various benefits of options trading, several investors are already looking forward to investing in the option chain and making the proposition lucrative.
Options contracts are a choice, not the obligation to buy or sell a security at a particular price and date. If you are a novice and intrigued to know more, then know all about options trading here.
What is Options Trading?
In the options contracts, the investors speculate whether a stock price is going to increase or decrease in the future at a specific date. Option buyers need to pay the price or ‘premium’. If the current price is unfavorable, they may want the option to expire without exercising their right. Conversely, the investor can move ahead for a valuable investment.
Here are some jargon that you must know to understand options in detail.
Derivative: Options or derivatives means that a stock price determines the value of the option contract.
Call option: A call option means the investor can buy a security at a fixed price on a specified date.
Put option: A put option means the investor can sell a security at a specific price and date.
Strike price: This is the predetermined price.
Expiration Date: Every option contract has an expiration date to allow the investor to exercise the option.
Premium: This is the price at which one can buy an option. This price depends on the underlying security’s price and other values.
Intrinsic value: The intrinsic value is the difference between the strike price and the current price of a security.
Extrinsic value: This term represents the factors that determine the premium.
ITM: A call option is ITM when the strike price is less than the current price of a security. A put option is ITM when the strike price is higher than the current price.
ATM: At the money or ATM, the strike and market prices for security are the same.
OTM: OTM or out of the money in a call option means the strike price is higher than the current security price. A put option is OTM when the strike price is lesser than the current security price.
Options Strategies
A novice investor can resort to the following types of strategies:
Married put strategy: The married put is about purchasing ATM put to cover stock long position.
Protective collar strategy: This is the strategy when the investor in the long position purchases an OTM put and also writes an OTM call for the same security.
Long strangle strategy: In this strategy, the buyer holds long on the OTM call, and OTM puts simultaneously with the same expiration date on different strike prices. You must know that the strike price is less than the call strike price.
Vertical spread strategy: This is the strategy where the buyer simultaneously buys and sells the same option type – puts or calls at different strike prices.
How does it work?
Using various options trading strategies, using the call options, you can bet on increasing prices, and using put options, you can wager on falling prices. Options contracts allow the investors to buy or sell at least 100 shares. When the investor decides not to exercise options, they will only lose the premium. Hence, options trading is treated as a low-cost investment type.
The investor can speculate whether a security price will become higher or drop, by how much money, and by what date in the future.
With the call option, when the underlying stock price becomes higher than the break-even price, you can sell and close your position. This way, you earn the money, which is a difference between the premium you had paid initially and the current premium. You can also buy the stock at a decided strike price. In the case of a put option, when the stock becomes less than the break-even price, you can sell and close your position. Again, you earn the difference of premium or sell at the agreed price.
When the stock price is unfavorable, just let the contract expire while you will have to suffer premium and trading fees.
The benefits of Options Trading
- Options trading offers great flexibility by allowing the traders to observe how things are working out on the Options Trading App without necessitating them to execute a trade.
- Since options contracts have an expiration date of days or months, the traders can limit their exposure for a lesser time period.
- Options trading is a fabulous hedging tool. An investor can buy put options and mitigate losses when the stock price falls. Nifty 50 is very commonly used as a hedge for short market declines.
- Options trading is a low-risk and cost-efficient way to speculate bets.
- Options trading has the potential to offer huge returns.
Wrapping up
Options offer many strategies for beginner investors and permit them to make a profit from trading underlying stocks. You can use different Options Strategy Builder and combine options, stocks, and other derivatives. Now that you have gathered enough information begin options trading with a small amount. Try aggressive options strategies later as you gain more experience and confidence.
