Stock Options Trading Guide – Basics You Must Know

Wednesday, June 1, 2016, 6:00 AM | Leave Comment

An average stock trader will buy promising assets with the hope of selling it for profits, in the due course. This technique works perfectly fine for the long term investors.

For medium or short term traders, ‘Stock Options’ investment is the best solution.

Stock option basics

So, what are stock options? Basically, it is a contract between stock option buyer and the purchaser. In this kind of trading, physical transfer of stocks is not involved, but trades are made on the price movement of an underlying asset, within a specified time.

Terms used in option contracts:

  1. Call option – Buyer buys the rights of underlying asset.

  2. Put option – Buyer sells the rights of underlying stock.

  3. Strike price – Price at which you buy or sell the underlying stock.

  4. Premium – Option buyer has to pay seller a premium in exchange of rights. Premium amount depends on volatility, strike price, and remaining time left till the expiration period.

  5. Expiration date – Expiration dates are specified for each option contract. After the specified expiry date, your options contract nullifies. Expiry dates depend on option style you choose.

  6. Option style – It can be either European or American style. In the American way, options can be implemented anytime prior expiration. In the European style, it is exercised on the expiry date itself. Currently, all stock options are traded in American style.

  7. Underlying asset – It refers to shares of a particular company. Moreover, options are available for other assets like indices, commodities, and currencies.

  8. Contract multiplier – It defines the underlying asset quantity, which needs to be provided, if option is exercised. In a stock option, each contract comprises of 100 shares.

  9. Option market – Options buyer are called holders and options seller are called writers.

Why invest in options?

Options can be efficiently applied under any kind of market condition. It means you can trade on rising, as well as on the falling equity prices.

The main features why you should invest in options are –

  • Leverage

    Investors get a chance to fix price of an underlying instrument, for a limited timeframe. They can buy or sell 100 shares for premium. Premium is a small percentage of the total value of the physical share. Thus, traders get leverage for investing, and for improving their chances to make profits from the shares’ price movements.

  • Protection

    Stock option investing allows investors to add insurance within their trading plan. During high fluctuations in the market, protective put options allow you to hedge a long position. It helps you minimize the losses against a sharp drop in the price of the underlying stock.

  • Volatility trading

    Option investors can bet on upward or downward price movements. You get money making opportunities when there is a movement, and even when there is no movement, of the underlying stock price. In this kind of trading, investors get a good chance to profit in any kind of market conditions.

  • Limited risks

    In option trading, the buyer will be well aware of total loss amount. He cannot lose more than the options price, or the premium.

Options trading is one of the most successful investment tools. It allows investors the flexibility, protection, and excellent means to diversify their portfolio.

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