Trading options is not as complicated as you might think. Trading stock options can be a very lucrative way of making money if it is done correctly. Stock options trading have become more popular with the advent of online trading accounts, which allow investors to trade stocks and other securities without paying any commissions on trades. Trading stock options will give you the chance to make big profits when your predictions are correct and limit your losses when they are wrong.
This post will provide an overview for beginners about what Trading Stock Options are and how they work so that readers can get started in this exciting field.
Trading Options vs. Direct Asset
Trading stocks directly is when you buy or sell them straight from the issuing company. Trading options mean that you are trading contracts with set expiration dates and strike prices to capitalize on price changes, for which there can be an unlimited risk and a total potential gain. When buying stock options, your broker will most likely require a margin account. Trading options are not for beginners, so if you consider this kind of trading, it would be wise to learn the basics first.
Buying Calls
This is the simplest option trading strategy. It involves buying options with a bullish outlook, where you expect your stock price to rise over time. These are known as Call Options, and if they provide enough value for what they cost relative to future market prices, it can be one of the most profitable strategies in an up-trending market.
The key to success with this options trading strategy is the ability of your stock’s price to move in a positive direction. Trading calls when you think that the market will do nothing but fall can be very costly and should only be done by experienced traders or those willing to take on highly risky trades. According to Vig, even failure means making money since calls always retain some value regardless of whether or not the price goes up. Buying Calls is one Trading Stock Options strategy used in both bull and bear markets to turn a profit if done correctly.
Buying Puts
This is the second simplest option trading strategy. It involves buying options with a bearish outlook, where you expect your stock price to fall over time. These are known as Put Options, and if they provide enough value for what they cost relative to future market prices, it can be one of the most profitable strategies in the down-trending market. Trading puts are great for investors looking to make money regardless of whether the market is up or down, but there must always be a significant fall in price.
Using this trading strategy, you can protect your current investment with put options that will ensure the minimal loss, if any at all. Even when prices drop dramatically, it’s not a brutal hit, especially if you have a diverse portfolio. Trading is excellent for those who are heavily invested in one stock but want to protect their holdings from a dramatic price drop or just entering into the market and looking not only to profit during an upsurge but also when it’s bearish as well.
Covered Call
Trading stock options can be a great way to generate income. Covered call trading is one option strategy that investors use to get paid for their shares while waiting to appreciate. This type of trade works best when you own the underlying stocks, but it can also work with other types of investments. Trading options can be a highly lucrative practice, but knowing what you are getting into before diving in is essential.
A covered call trade is when you sell someone else a contract on your shares of stock. This means that the other person has bought options to buy your supplies at a specified price for a certain amount of time, and they will get paid if and when they decide to exercise their option. You can think about it as a bet between you and the other person.
If the price of your shares goes up, then that is good for both parties because they will be able to buy them from you at a higher price than what they paid when they first bought their options contract, and if it doesn’t go up, then neither one of you loses any money.
Protective Put
A protective put is buying the underlying stock and purchasing a put option with an exercise price corresponding to your bought-in strike price. This strategy has two benefits: you own the stock at a lower cost than purchasing it without owning puts. You protect yourself against downside risk because you have both long exposure to the asset and hedging yourself through puts.
If you are looking to “protect” your stock position, the two most common ways of doing so are using a protective put or purchasing covered calls. Each has its benefits and drawbacks, which vary depending on individual circumstances. A protective put will generally cost less, but it does not allow for income generation like buying call options.
Trading options can sometimes get complicated, and you must understand what type of investor each trading vehicle caters to before committing any capital.
The Bottom Line
Trading stock options can be a very profitable business if you follow the correct steps. Trading is also only recommended for those with experience with trading or investing to ensure that they know what they are doing and take all of the necessary precautions to protect themselves from any financial loss. Trading is not for everyone, but if done right, it can be a very profitable business. Trading is a highly complex task, and it’s easy to do wrong.
Even if you have experience trading or investing in the stock market, options can be much more difficult because of their volatility, which means that even small fluctuations in prices can lead to significant changes in profits or losses. Trading stocks with an option contract allows you to make money from both rising and falling markets for different reasons.
