Basics about Trading Options

Why trade options in the first place? You might have the uncanny ability and luck when a specific stock is going to move lower or higher, so why not buy them? This same scenario also applies to commodities. Why in the world would you choose another when it is easier for you to handle futures contracts? You can read more about futures contracts when you click here.

Lots of people look for options as things built on speculation. But this is not true. If you want to get the most out of them, you should consider how they were designed and used as investment tools. They will significantly reduce your risks if you know how to handle them.

Things to Know to Get Started

  1. Options are contracts or agreements between two people: the seller and the buyer.
  2. The OCC guarantees the trades. The good news is that there was never a default scenario in OCC’s history for over 40 years.
  3. You must select from the two types of this investment: They are called puts and calls.
  4. The buyer pays what you call a premium to the seller.
  5. When the seller receives the premier, he can then grant specific rights to the buyer while he will accept particular obligations.
  6. The “call” types give the owner the right of buying an item or a contract at a strike price for a limited time.
  7. The “put” types grant the owner to sell an item at the strike price for a time.
  8. The contracts can be made up of 100 shares, and they are often called underlying assets.
  9. The limited-time can be defined as the expiration date of the option. The equity can expire every 3rd Friday of the month and after the market closes off.

Why Trade Options?

  1. Insurance– There is insurance designed to protect your portfolio’s value just like they do in a home or a car. When you use these types of investments as trading tools, you will be able to get insurance with little to no extra cost at all.
  2. Leverage– You won’t have to trade stock shares with options. You can be in a position where you can invest with a far lesser capital than what you’ll do when it comes to outrightly buying shares.
  3. Risks are Limited– There are lots of strategies present that can prevent any losses and at the same time, a high chance of success. You can check options trading books that can give you a clear guide on what you should do when you are into options.
  4. Hedging– You can significantly reduce your risk while investing in the stock market. If you strategize carefully and use hedging to your advantage, losses can be prevented. Some investors will appreciate the unnecessary suffering when they feel that their losing chances are slim to none.
  5. Income– If you sell your stock at a call option or a predetermined price, you get paid by what you call a premium that you can consider as a dividend.

How To Value Options

While the stock can depend on the market’s demand and supply, the options can depend on many factors. Each of these factors can affect the price. Here are some of these.

  1. Underlying Price

Whenever you have a call option on your hands, it is essential to note that you can buy a stock at its strike price. An example of these is when you own an NOV 50 call, you can buy a hundred shares of these at $50 a share. There are times when you may want to pay more to own a call when the stock goes to $39 than if it’s $35. This just shows that the underlying asset is rising and the calls are pricier when the stock rises.

  1. Expiration

When you own a specific type of option, you may want to check if the stock will move higher or lower. The more time you have before the expiration date, the higher the chance that positive changes are bound to happen. The more time left, the more valuable the derivative is. Read more about derivatives here:

  1. Interest Rates

Call options are alternatives for many traders in owning stocks. When you buy a particular stock, you need cash for the transaction. But for other investors, that cash can be used to earn interest. Therefore, the more you earn on the cash, the more you can pay for the call option. However, it is essential to note that this is not an important factor when you are trying to determine your derivative’s value.

  1. Type

Calls can give you the right to buy shares while put can let you sell the shares. Therefore, you won’t expect the put and the call to move at the same time. This is because when a specific stock moves higher, the call derivative increases in value while the put ones will decrease.