Options Trading – All You Need To Know

In financial terms, options trading is a contract between two parties, which gives the right to the buyer to buy or sell the concerned asset at a future date and at a fixed price. It is called options trading because there is no obligation on the buyer to go through with the transaction. The buyer of an option pays an amount known as a premium to the option seller. The seller of the option is also known as the writer.

Strike Price: This is the fixed price at which the call option can be bought or the put option be sold.

Types of options:

Two types of options trading exist.

 A Call option
 A Put option

The call option gives the buyer the right to buy the underlying asset, whereas the put option gives him the right to sell the asset.

Advantages Of Options Trading

Flexibility: You can use options trading for a variety of strategies. This can be used in conservative as well as high-risk scenarios. They can be tailored to a range of expressions, not jut the price of the stock.
Limited Risk: The risk is only limited to the premium paid on the option. (the exception to this is writing for a security which is not already owned)
Leverage: The investor has a clear leverage since he is not committed to the trade.
Hedging: Options trading also allow the buyers to safeguard their positions from fluctuating prices, when altering the underlying position is not desired.

Disadvantages Of Options Trading

Costs: The cost involved in trading an option is comparatively higher on a percentage basis.

Complexity: Options trading is relatively complex, it requires close scrutiny and observation.

Liquidity: With different strike prices, some of them will suffer from low liquidity, which makes trading difficult

Option Traders

There are two main types of players.

 Risk Seeker (also known as speculator): This is a type of trader who tries to profit from a prediction in the market direction.
 Risk avoider (also known as hedger): This type of trader uses the option market to insure his position against the market moving adversely.

Some Key Terms

1. Option Style: This indicates whether it is possible to do options trading before the expiration date or not. If you have a European option, it cannot be exercised before the expiration date. However, the American option can be exercised anytime during the contract.

2. Option Value: The price of the option comprises the intrinsic value and the extrinsic value. Intrinsic value is the portion that can be realized if the option is exercised. When options trading is done at more than the intrinsic value, it is known as Time Value or Extrinsic Value.

3. Volatility: This provides an estimate of how much a stock can be expected to move over a given time frame.

In options trading, you need not be familiar with the entire market. You can focus on a few of your favorite asset instruments; closely observe the price movements and patterns. You can then plan a strategy to earn from those patterns.