Trading options is different from trading stocks, which gives investors ownership in a company. With options trading, contracts are traded based on securities, but the risks are lower. Just what is an option anyway?
An option functions like a contract. An investor can use it to buy or sell a security, exchange-traded fund, or index at a pre-negotiated price (strike price). They can even decide on the amount of time they have to buy or sell an option. An option’s price (or premium) is a percentage of an underlying asset or security—options are thus known as derivative securities. A premium is the cost of paying for this bet—a percentage of that asset’s value.
The concept lies in betting whether an asset will go up or down in price.
How to Use Trading Options
Investors are not obligated to buy or sell the securities they trade, but they have these two options in the process:
- Call Options: Enable the investor to buy shares, usually 100 per contract, and choose to buy financial instruments if they go up in price before the contract expires. First, you buy the contract, pay the premium, and then buy the security at a set price. You must regularly renew the option, while its value decreases over time—the lower the strike price, the more value it has.
- Put Options: These are contracts to sell shares of a security or commodity at a given price for a certain time. The trader can sell the security before the contract expires. Strike prices and premiums apply with put options as well. Unlike calls, the goal is to have the security drop in price before you buy them. If you’re buying a put option, you want its price to be lower; you can sell a put option if its price is expected to increase.
There are various trading strategies investors use. Straddles are used when the asset is expected to be volatile but you don’t know if it’ll go up or down. A strangle is a relatively safe trade where an investor buys a call and put simultaneously for the same asset at the same expiry date. A covered call is when you sell only a fraction of the shares purchased, reducing the risk of current stock investments while providing an opportunity to profit. These are just a few of the many strategies used in options trading.
Benefits of Trading Options
Options can increase the income on investments regardless of fluctuations in market prices. Without investing in equities directly, you can capitalize on their rising or dropping over time and find better deals on them. Additionally, buying an option is less of an investment than buying the stock, and it gives you time to assess its performance. You essentially lock in a price and aren’t obligated to buy, which protects your financial investment.
Learn More with Momentum Options Trading
If you want to learn more about options trading, sign up for one of our membership levels today. We’ll help boost your trading profits and provide access to the best stock trading platforms. Sign up for our options investing report or call 540-429-0998 today!