Before we get into options trading and all the technical terminologies, let’s discuss the basic definition of options in the first place.
What is an option?
An option is a purchasable contract that gives you the right to buy or sell stock at a specific price agreed upon or before a specific date.
Options can be categorized into the following two types;
1– Call option: A call option grants the option holder the right (but not the obligation) to buy the stock at an agreed price on or before a specified date.
2- Put option: A put option grants the option holder the right (but not the obligation) to sell the stock at an agreed price on or before a specified date.
The agreed-upon price is what we refer to as the strike price.
The particular date is what we refer to as the options expiration date.
Suppose you purchase a call option; you are the option holder. The option’s strike price is 100, and it expires in 20 days. If you own this call option, you will be able to buy 100 shares per share (strike price) at any time for the next 20 days, regardless of where the stock will go in the future. So if your stock spikes to 130 in the next 20 days, you’re in luck. The stock is currently trading at 135, but there is a call option to buy the stock at 100. The same conception applies to put options. You can hedge the risk of selling the stock at a lower value.
Why do investors take a risk?
The basic idea of options is that an investor has risk, but he’s willing to pay someone to take away his risk, and the person who gets paid now assumes that investor risk.
Fun fact!
The coolest thing about options is that you don’t have to own stocks to trade options. You can trade the fluctuating option prices with your brokerage account.
How to trade options?
Open an options trading account.
- Before an investor initiates trading options, he must be aware of all the technicalities of trading. Also, he may require more investment for opening an options trading account than the stock trading account.
Brokerage firms screen out potential options traders and evaluate their trading experience, risk understanding, and financial readiness. These details are documented in the options trading agreement that sought future brokers’ approval.
Pick which options to buy or sell
- The direction in which the stock is expected to move will determine the type of options contract signed.
ü If you think the stock price will go up: Buy call options and sell put options.
ü If you think the stock price is stable: Sell call options or sell put options
ü If you think the stock price will go down: Buy put options, sell call options.
Forecast the option strike price
- It is only worth it if you buy an option if the stock price closes at the option’s in-the-money expiration date. This means either above or below the strike price. (For call options, it is above the strike price, and it is below the strike price for put options.) You need to purchase an exercise price option that reflects where you think your stock is in stock for the option’s life.
Determine the option timespan
Every options settlement has an expiration duration that shows the ultimate day you may exercise the option. There are two options, USA and Europe, depending on when you can exercise your option contract. US option holders can exercise at any time until the maturity date, while European option holders can only exercise on the maturity date.
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