Options trading is an intriguing branch of finance in which traders can speculate on the price movements within the stock market with unparalleled flexibility and control over their risk. While stocks represent ownership in a company, options are financial contracts that afford traders the right-but not an obligation-to buy or sell an asset at a prespecified price within a predetermined time.
To the uninitiated, options may appear daunting; however, once the basics have been mastered, it opens up a whole new world of trading strategies and opportunities. What follows is an explanation of some of the key concepts and a couple of basic strategies for getting started in options trading.
Keystone Concepts in Options Trading
Calls and Puts
There exist two kinds of basic options: calls and puts. A call option provides the buyer with the right to buy an asset at a certain price, normally referred to as a strike price, prior to expiration. This is typically employed when traders anticipate that the price of the asset will increase. On the contrary, a put option provides the buyer with the right to sell an asset at the strike price prior to expiration and is therefore employed at times when traders forecast a fall in the price of the asset.
Strike Price and Expiration Date
Every option has a strike price and an expiration date. The strike price is the price at which, depending on the option type, one can buy or sell the asset. The expiration date is the last date when the option has to be used. After that date, the option becomes worthless, and this is what makes time crucial in trading options.
Premium
Option premium is the price paid to buy an option. The determining factors of premium are the current price of the asset, time to expiration, and volatility in the market. The premium, all things being equal, tends to be higher when the current price of the asset is closer to the strike price and the more time is left until expiration.
ITM-At-the-Money-OTM
ITM: A call option is in-the-money when the current market price of the underlying asset is above the striking price or when the put option is below the striking price.
At-the-Money (ATM): An option is at-the-money if the price of the asset is equal to the strike price.
Out-of-the-Money (OTM): A call option is said to be OTM if the price of the underlying asset is below the strike price, and in the case of a put option, when the price happens to move above the strike price.
Understanding these basic terminologies is quite required for the analysis of options and henceforth choosing an apt strategy.
Basic Options Trading Strategies for Beginners!
Covered Call Strategy
The covered call strategy involves owning a stock and selling a call option on that stock. It is employed when a trader expects the stock price to be relatively stable or slightly higher. Selling the call option realizes some income in the form of premium, which can be a buffer against any decline in the stock’s price.
On the contrary, if the price of the stock goes above the strike price, he is bound to sell the stock at that price and hence tend to miss on further gains.
Protective Put Strategy
The protective put, also called a “married put,” is a purchase of a put option on an already-owned stock. Due to this fact, it acts like an insurance in case the stock starts to decline in price.
When the stock price falls below the strike price, the trader will exercise the put option and could sell at the strike price to cap the losses. Protective puts thus work in up-and-down markets where one would want to retain an issue for its longer-term prospects but still wish for downside protection.
Long Call Strategy
The long call is a simple strategy suitable for those just starting to trade options, in which an investor expects a stock to undergo significant upward movement. This involves buying a call option to gain exposure to potential upside in the underlying stock’s price without actually needing to purchase the stock itself.
This way, if the stock price rises above the strike price before expiration, he can exercise the option to buy the stock or sell the option at a profit. The only cost of this strategy is the premium received, and it’s a good strategy to have limited risk while taking part in the upside potential.
Cash-Secured Put Strategy
The strategy behind the cash-secured put is to sell a put option on a stock that he is willing to buy at a lower price. As he sells the put, he will be able to collect the premium-a profit which he gets to keep should the option expire worthless.
He has to purchase the stock in the event of the stock price falling below the strike price, but as he was prepared for this eventuality, he reaches his goals. The entire strategy is another way of taking delivery of the stocks at a discount while earning revenue from the premium collected.
Conclusion:
The options trading enables one to be versatile and to implement various strategies according to market conditions. These simple strategies, such as covered calls, protective puts, long calls, and cash-secured puts, will provide a good base for options trading beginners without being exposed to too much risk.
These ideas are going to take a lot of time and practice to get a hold of, but with good discipline and crystal-clear comprehension of each strategy, options trading can prove to be a rich constituent of diversified trading.
