Financial markets have enjoyed a wide array of investment options over the years.
One of the most popular trading means available is options trading.
Option trading allows you to leverage the many different features that other markets don’t offer.
This post goes through options trading and everything a beginner trader needs to know about options trading.
NOTE: Get your Options Trading Strategies PDF Download Below.
What is an Option?
An option is a conditional derivative contract that permits contract buyers to either buy or sell an asset as a predetermined price. To make it happen, the sellers charge the buyers an amount called a “premium.”
If the price of the asset becomes unfavorable for the options holders, the option will expire worthlessly. This can make sure that the losses are not above the premium amount. However, the option sellers (also known as options writer) takes on a greater risk than the option buyers, which is the reason why they charge the premium.
Options are divided into two major categories; call and put options.
What are Call Options?
A call option is a financial markets contract that gives the buyer the right but not the obligation to purchase an agreed security at a predetermined price within a specific time period. The security could be a stock, commodity, bond, or other assets. The buyer of a call option profits when the price of the underlying security increases.
What are Put Options?
With a put option, the owner has the right but not the obligation to sell an agreed asset at a predetermined price within a specific time frame.
The buyer of the put option has the right to sell the asset once it hits the predetermined price.
Options Trading Example
Let’s say that on June 1st, the stock price of ABC is $100 and the premium is $5 for an August 70 call. This shows that the expiration is the 3rd Friday of August, and the strike price is $105.
The total price for the options contract is, therefore, $5 (premium price) x 100 = $500. We multiply by 100 because, in most options contracts, the option is to buy 100 shares.
The strike price of $105 means that the price of the stock has to rise above $105 for the call option to be worth something. If it is below this, then it is ‘out of the money’ and not a profitable position.
After a few weeks, the stock price is up to $110. This means that the options contract has gone up by $5 x $100 = $500.
Deliverable and cash-settled options
A deliverable settled option is a type of option that requires the transfer of the underlying stocks or asset that the option has a contract on.
For some options contracts they are cash settled. This means the difference between the strike price and the expiry price will be paid out in cash.
Options Trading Risks
Some of the risks associated with options trading include;
- Option writers are exposed to amplified losses because the seller is obligated to sell an asset at a specified price within the time frame of the contract.
- Limited time for an investment to work out. Options trading is usually short-term as investors are looking to capitalize on the short-term price movement of an asset. You will need to make correct assumptions, or risk losing.
- Traders need to meet certain requirements before they can trade options. Options are a more advanced way of trading.
- Options traders tend to incur extra costs and fees that could affect their profits.
Benefits to Trading Options
Some of the benefits of trading options include;
- It is cost-efficient: Options have massive leverage power, allowing investors to obtain an option position similar to what is experienced with stocks but with lower cost.
- Less risky: if used properly, options trading can be less risky than owning stocks. This is because options require lower financial commitment compared to equities and similar markets.
- Higher possible ROI: with options you spend less money and earn as much profit as you will when you trade stocks. The percentage return in options is higher than what you will make trading stocks.
- Investors enjoy synthetic positions: synthetic positions in options trading provide traders with extra ways of attaining the same investment goals. Also, options offer various strategy alternatives for traders to use.
Options Trading Strategies
There are numerous options for trading strategies. The popular ones include;
This strategy is popular among options traders because it generates income while reducing the risks of being long on an asset. It involves buying a stock and simultaneously writing or selling a call option on the same asset.
With this strategy, the investor buys an asset and simultaneously purchases put options for the same number of shares. The holder of this put option can sell the stocks at the set price, with each contract worth 100 shares.
The long strangle strategy involves a trader buying an out-of-the-money call option and an out-of-the-money put option simultaneously, on the same underlying security, and with the same expiration date.
Long Call Butterfly Spread
This involves a combination of two different contracts. This strategy involves an investor combining a bear spread strategy and a bull spread strategy.
The iron condor strategy is where the trader simultaneously holds a bear call and a bull put spread.
The trader buys an out-of-the-money put option and sells an at-the-money put at the same time. The trader will also buy an out-of-the-money call option and sell an at-the-money call.
Bull Call Spread
This involves buying calls at a set price and selling the same number of calls at a higher stake price simultaneously. The two call options will have the same underlying asset and expiration date.
Bear Put Spread
This is a form of vertical spread where the trader simultaneously buys put options at an agreed strike price and sells the same number of puts at a lower strike price.
This strategy comes into play by buying an out-of-the-money put option and writing an out-of-the-money call option at the same time. The underlying security and expiration date of the contract remains the same.
This strategy takes place when the trader simultaneously purchases a call and put option on the same asset or commodity with the same expiration date and strike price.
Options Trading Broker
Avatrade is one of the best options trading brokers currently available to traders globally.
To make it easy for you, Avatrade supports 13 major trading strategies, provides automatic spreads and also risk reversals for some trading strategies.
The interactive page on Avatrade makes it easy to trade options or Forex. The historical chart indicates the past, while the confidence interval displays the likely direction of the market.
Options Trading Platform
The Avatrade options trading platform is one of the best at the moment.
With AvaOptions, traders have more control over their portfolio. You can also balance your risk and reward to match your market view.
AvaOptions comes with professional risk management tools, portfolio simulations, and much more.
Options trading provides alternative trading strategies, allowing you to profit from the underlying asset.
There are various strategies involved in trading options, and it is best to choose one that favors your trading style.
Keep in mind: whilst there are many benefits to trading options, there are also risks you need to be mindful of.