A Short Guide to Stock Options Trading
Learning about trading options can be difficult for beginners. Strike prices, puts, calls, and premiums are all terms that can seem confusing and make it difficult for a person to make sense of options trading.
What Is an Option?
The best way to understand options is to compare them to stocks. When a person buys a stock, they purchase a small portion of a company, which is referred to as a share.
You can make money by anticipating if a business is going to grow or not in the future. If the stock prices rise, you can sell the stock and make a profit.
Options are contracts that give you the right to buy or sell a stock or underlying security. These are usually done in bundles of 100. The price for the stock is pre-negotiated, and the sale must take place by a specific date.
When the date arrives that was predetermined in the contract, you are not under obligation to buy or sell a stock. You have the option to allow the contract to expire. That is why it is referred to as an option.
However, when you purchase an option, you will pay a premium upfront. If you let the contract expire, you will lose the money spent on the premium.
Options contracts can be divided into two categories.
- Put Options. A put option gives you the ability to sell a company’s stock at a pre-agreed price before its “expiration.”
- Call Options. Call options let you purchase a company’s stock for a specific price within a time, which is called the “expiration.”
After you purchase the contract, a few scenarios can play out up until the contract expires. First, you can exercise the option. This means that you can buy or sell the shares of the stock at the strike price. The second option is to sell the contract to another investor who wants to purchase it. The final option is to walk away from the contract with no financial obligation.
Why Do Investors Trade Options?
When you look at an options trading guide, you will see several reasons why investors trade options. One of the advantages is that they can control more shares than you would be able to handle if you purchased the stocks directly for the same amount of money. Additionally, options are a type of leverage. This means that for the money you invest, you have magnified returns.
With an option, an investor can watch and see how things play out. Investors can mitigate some of their risks by locking in a price.
What Are Basic Options Strategies for Beginners?
Some basic options strategies for beginners include the “Long Call,” the “Converted Call,” the “Long Put,” and the “Short Put.” Each strategy has its pros and cons, allowing the investor to anticipate the stock price and then invest money with a level of risk they are comfortable with.
According to the experts at SoFi, options “give holders the right but not the obligation to buy assets, like shares of a company stock.” This makes them a flexible option for beginners.
Some associate options with high risk. However, several basic strategies can be used to limit risk and increase potential gain.