Futures And Options Trading Guide - A Beginner's Guide on How to Trade Options
Futures And Options Trading Guide
Most people believe that options trading is risky. However, we believe that the risk lies in the strategies used while placing the options trades. If you use basic risk management strategies options trading can be less risky than trading stocks.
First, lets discuss what options are. They are contracts which give the investor/trader the right to buy or sell some underlying instrument (e.g. a stock or a bond) at a predetermined price called 'strike price' on or earlier than the expiration date. This might sound complicated but it isn't. It'll be easier once you read the example that comes later.
Before we start, we should discuss the two different types of options you can buy - puts and calls. A call option is the right to buy an asset at the strike price on or before the expiration date. You would buy a call when you expect the price of the asset to be higher in the future.
Similarly, a put option is the right to sell an asset at the strike price on or before the expiration date. When you expect the price of the asset to be lower in the future (prior to expiration) you would buy a put option. This is similar to shorting a stock. Futures And Options Trading Guide
Ok, now let's have a look at an example:
Assume that you believe that the stock of a company is going to rise in the near future. So, you decide to buy a call option contract for $1.50 with a strike price of $50. A single options contract corresponds to buying 100 shares of the company. The total cost would be - ($1.50 + $50) * 100 = $5150. When the market price is above $51.50 then you can sell your option and make a profit. But, let's consider an alternate scenario where the market price falls lower than $51.50 and appears to be heading lower. In such a situation, it makes sense to sell to avoid losing more money.
There is one more option. You could just let the contract expire. Unlike futures, there is no obligation to buy or sell the underlying asset but you have the right to do so. Whether you decide to just swallow the premium depends on the strike price and the market price.
As you might have noticed, options have similar uncertainties to stocks - rapid rise or fall of price in varying time frames. But, the important difference is that there is an expiration date. So, with time, the option price can vary. The change is affected by the movement of price of the stock and the time left to expiration. Futures And Options Trading Guide
Futures And Options Trading Guide - A Beginner's Guide on How to Trade Options
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