Trading options can be more complicated than trading stock.
That’s because, while you initiate a stock trade with an order to buy or sell, an options order might be buy to open, buy to close, sell to open, or sell to close.
What are options
An option is a contract to buy or sell a specific financial product officially known as the option’s underlying instrument or underlying interest. For equity options, the underlying instrument is a stock, exchange-traded fund (ETF), or stock index.
Options come in two varieties, calls and puts, and you can buy or sell either type. The owner of a call option has the choice to buy stock, whereas the owner of a put option has the option to sell shares.
Call option buyers use them as a hedge against their position if the price of the security or commodity falls. Put option buyers use them as a hedge against their position in a security or commodity whose price is expected to rise.
What are options trading?
Speculating on the future course of the general stock market or specific instruments, such as stocks or bonds, is what options trading allows investors to do. When you make an initial investment in an options contract, you are opening a position by either buying or selling the contract. Then, at any point before the option expires, you can close your position.
If you are holding a call option, and you can sell it for more than you paid to buy, you might close to realize a profit. You might also close to limit a potential loss if the option seems destined to remain out-of-the-money. If you open a position by selling a contract, you might close that position if you think the option will be exercised since you could then be required to make good on the obligation to buy or sell. In this case, since you sold to open, you’d buy to close.
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How is an option trade executed?
When you make an options trade, you go through a brokerage firm, just as you do when you trade stocks. Whether you give the order over the phone or online, you’ll have to provide detailed information about the option you’re trading, including:
- The name or symbol of the option
- Whether you are opening or closing a position
- Strike price
- Whether you are buying or selling
- The expiration month
- Whether you want a put or call
- You are paying cash or using a margin account
- Whether you want a limit order or market price
You’ll have a chance to review your order, and you must double-check all the details. Once you’ve agreed to the trade, you’ll receive confirmation that your order has been placed. It means it has been added to the line of orders waiting for execution. Every time you make a trade, you’ll also pay a commission. The amount varies depending on the brokerage firm. However, it’s essential to consider the costs of trading when planning your options strategies.
How to trade options?
From a simple approach to detailed, complex trades, you can use various options trading methods. However, betting on rising prices is generally done by trading call options, and betting on dropping prices is done by trading put options.
Options can be used for four different things in general:
- Buy (long) calls
- Sell (short) calls
- Buy (long) puts
- Sell (short) puts
A superb option trading technique for newcomers and investors who are certain about the prices of a particular stock is to buy calls. Investors can benefit from rising stock prices by buying calls, provided they sell them before the options expire. Similar to buying calls, buying puts involves anticipating the asset’s value to fall rather than rise. Due to the much lower risk, investors frequently use this strategy instead of short selling.
Option sellers are known as writers of options, and option buyers are referred to as holders. You can simply let the contract expire for a call or put option, incurring losses equal to the option premium if the asset’s price moves against you.
What are fungible options?
Each exchange decides on the options it will list or make available for trading. The most widely traded options may be listed on all the exchanges, while others might be listed on only a few or just one. However, there are some basic standards that all the exchanges adhere to in selecting the companies on which they’ll list equity options. Usually, eligibility for listing requires a minimum number of outstanding shares and a minimum market price for the stock. If a company on which options are listed fails to maintain the minimum requirements, an exchange may decide to drop the listing.
All listed options are fungible, which means the contract terms are identical from exchange to exchange. That allows you to buy an option on one exchange and sell it on another to take advantage of the best available price. In most cases, your brokerage firm determines where the transaction will take place. Listed options are traded on self-regulating exchanges (SROs). Those are regulated by the Securities and Exchange Commission (SEC), the federal agency that governs the securities industry. For example, the SEC approves the standards that exchanges must use to list options, though each exchange can make its list selections.
How do you get approved for option trading?
Even if you have an account with a brokerage firm and are actively trading stocks, you’ll need to be approved before trading options. The rules are meant to prevent you from making options trades that might be beyond your ability to cover or that might expose you to an unacceptable level of risk. The brokerage firm will ask you for information about your investing experience and assets and will require you to read a document about the risks of options trading. You may also be asked about your knowledge of options strategies. Based on your answers, the firm will approve you for a specific level of trading, which determines the strategies you may use.
Different transactions also have different margin requirements. Those that expose you to greater risk require a higher margin.
Options Trading For Beginners [Full Guide] by Inna Rosputnia
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