You might have overheard other traders discussing stock option trading if you’re an investor in the stock market. Once you learn the ropes, options trading, like any other kind of investing, may be a lucrative way to increase your wealth. If you’re interested in learning more about options trading, we’ll provide a brief overview to help you decide. However, before you start trading, it’s wise to conduct your research.
How does option trading work?
Under stock option contracts, buyers (or option holders) receive the right, but not the duty, to purchase or sell a specified number of shares in a corporation by a specified date. We will cover stock options for simplicity’s sake, but you can trade options on a variety of different assets, such as EFTs and indices.
Instead of buying the right to buy or sell stocks, why not just buy or sell them? For those new to trading, here are some definitions to help you understand:
The expiration date is the date on which an option becomes null and void. The time until an option’s expiration can be anywhere from a few days to two years in the future. Once this date has passed, the option will be ineligible for trading or exercising.
When an option holder decides to exercise their right to buy shares of stock, they do so at a price known as the strike price.
The multiplier for an option contract indicates how many shares the holder can buy at the strike price in the event that they execute their option. Standard practice dictates that most options will cover 100 shares. For example, when perusing your alternatives, you come across one listed for $3.00. At first glance, this may seem like a steal, but keep in mind that you’re only getting one share for the price of one in the entire contract. Therefore, the total asking price of $300.00 is the result of multiplying $3.00 by 100.
What makes stock option trading appealing?
One way to profit from stock price movements is through options trading, which involves predicting whether a stock’s price will go up or down over a specified time frame and then hoping for the best. Take the hypothetical case of firm XYZ, where you expect its share price to rise over the following month from its present $25.
An alternative to taking a chance is to buy a stock option that grants you the right to purchase 100 shares of XYZ for $30 per share at any point within the next 30 days. Imagine for a second that your prediction comes true and XYZ shares reach $50 within the next month. If you wanted to make a tidy profit, you might exercise your option and buy 100 shares at a steep discount.
However, if XYZ unexpectedly drops in value and trades at $10 per share in 30 days, you are not required to buy the shares. Even though you’ll lose the initial investment (the “premium”) in the option, it’s likely to be much less than if you got the shares directly.
Trading options in which you have zero interest might potentially yield a profit. You can always make a profit by selling it to someone else before it expires if you buy one and its value goes up.
Various stock option structures
There are a plethora of options, methods, and tactics to choose from as you progress in your trading career. However, there are primarily two kinds of options that newcomers to the stock market need to be familiar with.
Options on Call
At any time before the option’s expiration, the holder of a call option has the right to purchase one hundred shares of the underlying stock at the option’s strike price. Buying a call option gives you the chance to buy a company at a bargain after its price has soared, which is advantageous if you anticipate the stock is going to have a big upward price increase. Verify that you will make a respectable profit after deducting the option premium from the stock’s price drop below the strike price.
Optional Puts
At any point before the option’s expiration date, the holder of a put option has the right to sell one hundred shares of the specified stock at the strike price. You can use a put option as a financial instrument to protect yourself from the potential decline in stock price. For example, let’s pretend you own one hundred shares of a firm that is about to announce its earnings. Your agreement will allow you to sell your shares at a pre-arranged price regardless of whether the report is unfavorable and causes a precipitous decline in the company’s stock price.
Getting Started with Options Trading
A brokerage account with a trading platform, such as Schwab, TD Ameritrade, or WeBull, is required to start trading options. Additionally, you must apply for authorization to trade options, a process that often takes one or two days, according to industry rules. Your financial status, risk tolerance, and level of experience are typically considered before granting approval.
For beginners, options paper trading platforms allow them to practice trading without putting their own money at risk. You can practice trading with virtual currency instead of real money on platforms like Interactive Brokers’ paper trading simulator and TD Ameritrade’s PaperMoney.
Once you’re ready to start making real transactions, all you have to do is go to the stock you want to buy an option on in your trading platform. To see which calls and puts are available for the stock, go to the website’s options area. After doing your research, choose the option that fits your plan. First things first: buy something. Then, monitor your selection daily to determine your next steps.
With any luck, you now have a solid grasp of the basics of options trading. If you’re already a brokerage account holder, you should definitely peruse your platform’s educational materials; many of them include guides to free options trading for newbies.
