Basic Stock Options Trading Guide and Overview

Are you looking to delve into the world of stock options but yet have not the slightest idea where to begin? Well, you are in the right place because we are just about to discuss the basics of stock options trading. Options trading is a multi-faceted topic that we cannot possibly cover in one sitting, but we can get you started on the journey to stock options success.

A Few Key Points on Options Trading

You are probably aware that an investment portfolio usually comprises several asset classes. These classes may be stocks, bonds, mutual funds and EFTs. Options can be classified into a class of their own as well.

· What is an Option?

An option is a contract giving the buyer the optional right to buy referred to as a call or sell (referred to as put) the asset in question. There are many reasons why investors purchase options, including hedging risk, speculating and, of course, making a profit. Investing in stocks carries a few risks that can lead to losses.

· Call and Put Options.

A call option gives the bearer the right to purchase a stock, while a put option gives the holder the right to sell a stock. There are various versions of these two options, including covered calls which you should read about.

· Options Categorized as Derivatives.

In essence, options belong to a larger group of securities commonly referred to as derivatives. Derivatives are also financial contracts whose value is tied to an underlying asset, benchmark or a group of assets. In the same manner, options are financial contracts whose value is intricately tied to other investments.

Reasons Why Investors Use Options

1. Speculating

Speculating in options trading can be considered an art form involving making calculated future price predictions. An investor can use current and past information to predict the price of an asset rising or falling with time. Speculating is an important skill in options trading because it allows investors to buy leverage assets.

2. Hedging

Hedging is like a game of chess. It involves moving pieces now to protect existing investments and create new opportunities in the future. Investors can also use options to reduce the losses incurred in risky assets. In essence, hedging uses options as insurance policies for existing investments. It is believed that traders created options trading purely for hedging purposes.

Final Thoughts

Options trading takes the form of gambling in more than one way. Essentially traders are gambling on what will happen in the future. The more probable an event is, the more expensive you can expect the contact to be.

The price of an option can also be determined by the time it has left before expiry. The less time there is before an option expires, the less the value an option has. This is because the probability of a price move diminishes the closer a contract gets to the expiry date, so investors have a lesser chance of profit from it. Volatility also affects the price of an option because the uncertainty increases the odds of an outcome higher.

Any big swing in asset prices also increases the chances of an event occurring which means options prices increase. In essence, the more unstable an option and its underlying asset is, the more value is attached to it.