Financial markets are full of opportunities for traders and investors. There are unique ways to invest in the market with various instruments. Options trading is one of the future trading investments available for traders.
They can invest in assets without any obligation to perform. Isn’t it an amazing choice for traders? To learn more about options trading, we have a brief explanation of the topic for beginners.
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What is Options Trading?
In simple words, options are a contract between two parties without any obligation to execute it. Traders use it to speculate on asset prices in future dates. Speculation allows them to bet whether the price will rise or fall.
Also, they need not buy the asset in actuality for trading. The parties decide in advance the contract execution date with time and price. Moreover, if they do not perform the trade, they have a loss of the premium paid for the contract.
For example, two parties enter into a contract of options with a company’s stock.
They decide the time and price of the stock trade at a future date. One speculates on the rise while the other on the fall of prices.
If the price of assets increases, the party betting on the fall pays the other party. Or they can decide to not perform the trade without any loss. So they only pay the initial premium of $20 on it.
Types of Options
It is necessary to have a base knowledge of options trading and its different types. Options are of two types basically; call and put options. Traders can select from these two and invest.
A call option is the right to buy the underlying asset. It has a certain price and date fixed for buying the asset. The price of the contract is called the strike price. And the date of execution of the contract is the expiration date.
A put option is the opposite of a call option. Traders enter into a future contract to sell the underlying asset. They can use their right to sell the asset at the strike price and expiration date.
Traders can trade the two options using the American or European styles. The American style allows traders to buy/sell anytime before expiration. In contrast, the European style allows you to buy/sell at the expiration date.
How does Options Trading Work?
Options trading requires a brokerage account to trade the assets. However, it allows self-directed trading to the investors. Below we have the process of how the options trading works:
What is Buying a Call?
Buying a call is to buy the underlying asset at the expiration date. It is a contract of purchase of the asset. Traders can go for this option type when they think the price of an asset will rise.
Traders can take care of the strike price and contract expiration date.
For example, you buy 50 shares of BBC and feel the price will rise. So you get into a call option contract to buy the 50 shares at $30 each. The price of shares reaches $50 by expiration time.
So, traders can use the right of call option and have the stock at a discount.
What is Buying a Put Option?
A put option gives the traders the right to sell the underlying asset. They buy the contract with a price and expiration date. Traders can use the contract when the price of an asset falls.
It is the opposite of the call option. Traders use it when the price of an asset falls below the strike price. Then, they use it to sell underlying assets at the strike price and get profits.
Few points to consider in options trading:
- How much to invest?
- What time frame should you trade?
- Anticipating the price movements for the underlying asset
Participants of Options
The options contract has four significant participants. Here we have them discussed one by one:
- Buyer: The buyer is the one who pays the premium to buy the right to exercise his options trading on the seller.
- Seller: Seller receives the premium; they are obliged to buy/sell the asset if the buyer exercises his option right.
- Call Option: The call option gives the trader the right but not the obligation to purchase an asset at a certain price before the expiration.
- Put Option: The put option is the selling right with no obligation. It gives the right to sell an asset before expiration on a set price.
Options trading is a unique way of investing in a future date. Traders can use call or put options right without any obligation. Moreover, it requires good research and study of trades for high market profits.
However, the risks of options trading are also high. Traders need good knowledge of the market to be successful.