Options trading sure is a concept few investors are accustomed with. When risk based heavy returns is generally referred, people ought to think about stock investment.
Capital market knowledge for some people is basically limited to Shares. Finance world has however outgrown investor’s expectations and offer a bunch of instruments for investment. Each instrument is distinctive in its own manner but basically work towards providing a common goal – proportionate returns.
We wish to guide you through Options trading, which is an alternative of stock trading. It provides promising returns, in the similar manner as shares do. Investing in share is commonly subject to long terms investment. This diminishes the short term return possibility from capital market, however Options fulfils the same.
Tables are turning, and capital market is witnessing a lot of investors from the options market. It is gaining up in the competition and running equivalent in stature, like the most demanded financial products.
What is Options Trading?
Being well read about stock market investment, you can expect similar fashioned trades. The basic fashioned dealing is of buying financial instruments and then later on selling them for higher price in the future, to gain profit. This is basically a long term investment plan, but options are the exceptions here.
Unlike other investment options, you can actually make small term gains via options trading. This is the reason why people are slowly and steadily turning towards option contracts, and we sure support you, if you wish to pursue this option.
Options Trading Constituents
Simply stated, you can buy and sell options (also referred to as Options Contracts), via public exchange. This may seem somewhat like trading in stock, but options is far more versatile. You get multiple choices here, where you can choose to invest in a variety of underlying assets.
Here, your scope of investment and also return in enlarged, on contrary to stock trading, which only comprises of shares. Here your arena of investing and earning returns is expanded, through speculations of large number of instruments.
The criteria and perk of underlying asset is not the only tag of versatility to options. There is a lot more of versatility options trading offers, and it is in context of various types of options and numerous options orders.
In options, you can either take a long position, or on the contrary, take a short position. If you perceive an option to rise in price for the near future, you can take a long position. On the other end, if you perceive the stock price will fall in the future, you can short sell the option. This option is sold with motive of buying it back in the future at low price.
This was just the basics, however, there are a lot of ways in which you can place a trade order. This assuredly increases your means of earning profits.
Well, the thing you must have already noticed is, Options trading is by far a complicated subject. Beginners will always find it extremely difficult to make amends with, but there is always a destination, though however difficult the pathway is. With the right amount of knowledge, you can take the path seamlessly and reach the destination.
This concept is exactly like buying shares of a company, where you buy the share to retain it for longer intervals. This is so you can sell the share in the future, for a higher price and gain profits. In the similar manner, you can place a buy to open order with a broker, and mention the underlying asset and its quantity.
On account of high price movement of the asset you bought, you have two actions you can make, i.e. sell or exercise. The point worth mentioned is the feasibility and versatility of options. Here, you can choose to buy a contract, when you anticipate the price of the asset to go up, and also when you expect it to fall.
The distinction of order placement here is, you must place a buy call options on account of future price rise anticipation. Contrarily, you can choose to buy put options, if you think the price of the asset will fall. Call options gives you the right of purchase of the asset in a fixed price. Put options gives you right to sell the asset at fixed price.
Similar to such a trade, there are a lot more varieties of trade you can attempt.
Selling and Writing Options
Selling options can be done in two ways. Prior manner is when you already have owned contracts and are in a view to realize the profits or cut losses. For the same, you must place a sell to close order to sell the contract. The name is derived from the action of thee trade, i.e. close the position by means of selling it.
Sell to close order is attempted when price of the contracts you own have gone up and you wish to take away the profits. The contrary reason for Sell to close order placement is the contracts has undergone a fall in price and you wish to withdraw the position you took, to safeguard yourself from further losses.
The other way in which you may sell your options contracts is, by placing a short position, to short sell the same. This order is referred to as writing option contract, as you write a fresh contract for the purpose of selling. Writing options contract refers to acquiring the obligation as well.
The obligation is, you have to sell or buy the contract at strike price, in case the holder of the contract wants to exercise their option.
It is when you perform a sell to open order placement that you write an option. In such as case, a payment will be made to you, when you make the order placement. Such a trade is highly risky, on the contrary end to simply buying and selling a contract. However, the perks attached with such an order are massive too.
The common way opted in options investment is buying, selling and writing of options, rather than exercising. This is bound to a change in order, on context with strategies used and reason for the purchase of specific contracts.
The idea here is simple; it conveys multiple ways in which you can make profits, including exercising your option. This is the kind of versatility options trading offer, and there is no denying that you can make money in a lot of ways.
This is an interesting aspect of options trading, creating options spreads. Options spreads is indeed a powerful tool, apart from the fact that you can make profit from buying and selling of contracts. In a spread, you can take a position in two or more options, based on same underlying asset.
To better explain the scenario, you can choose to buy options on a stock, while also write a contract on the same stock. You have the feasibility of creating a lot of spreads, for different situations. The motive to create such spreads is the minimize the loss which may have to incur, or to reduce the financials required for a position.
About Options Contract / Options Trading
Now that we have gained an insight into how options are traded, let us gain a specific idea about what options actually are. Options are basically derivative, which implies, their value is extracted from an underlying asset. An underlying asset can be anyone from – stock, index, bond, interest rate, currency or even commodity.
If you invest in an option, you deal with contracts, which provide you the rights to buy or sell an underlying asset, in accordance with a particular price, but on before a provided date. There is however no obligation of the same, i.e. to buy or sell the underlying asset.
There are merely 3 motives of investing in options, or you can call them the specific perks. People invest with the intention of gaining a source of income, speculation, or to hedge risk.
There are two participants in a contract, i.e. the holder and the writer. Writer is the one who sells the contract, other the other hand, holder buys the contract. You must also be well versed with the terms premium. Premium is the amount paid by buyer of the contract to the writer, at the time of writing the contract.
The one, who holds the contract, has the option to engage in the transaction, and writer is obliged to engage if the holder wishes to push through. When a holder initiates the specific transaction of the contract, it refers to exercising the option. If the option is not exercised, it will expire and cease to exist.
Strike Price and Expiration Date
Strike price refers to the amount which is specified and based on which the transaction will carry, if holder exercises it. It is also referred to as exercise price.
Expiration date, as it denotes, is the date at which the option will expire. The life of options last basically for few weeks, i.e. options are of short term in nature. This is not an obvious case scenario, as they can be for months or a year. In a case when the expiration date has surpassed without the holder exercising it, contract becomes useless.
Options Type, Style and Settlement
Classification of contracts can be done on various account, however it is summed down to rights of buying and selling. Based on the rights, it is call options and puts options. Holder gets the right to buy the underlying asset at strike price in call options. Holder gets the right to sell the asset at strike price in put option.
Classification based on exercising style is – American and European. European style of options is when the holder gets the right to exercise their option at expiry if he wishes to. American style of options is known for the amount of flexibility, and hence is offered for a higher price.
Classification based on settlement is – physical settlement and cash settlement. In physical settlement, buyer and holder of the contract transfer the contract on the expiry date physically, in accordance with the agreed strike price. In cash settlement, cash payment is made to holder in accordance with profit made through exercising.
Why Trade in Options?
We already give you a slight insight on the reason why people invest in Options, the three prior reasons. Apart from that, we wish to lay down the profit aspects for you, because of which, you must definitely consider trading in options. Let us begin with the prime ones, i.e. ease of transaction and high money making possibilities.
Cost Efficient Way of Gaining up on Capital
The best reason we would like to give, which would encourage you to invest in options is, make great returns without actually investing in a lot of funds. This opens the options market for every other kind of trader. The factor which fills up the gap of low investment amount and heavy profit is leverage.
Proportionate Rewards Provided with Risk Taken
Risk and reward go hand in hand, and strategies are all which change the risk to reward ratio. As we already mentioned, small amount of investments can fetch you a lot portion of profit, resulting into a cost effective way. You simply have to be well read about the strategies and how to implement to attain a better risk to reward ratio.
There are strategies which minimize the risk, where there also are strategies which have high degree of risk involved. Risk is basically present everywhere, but strategy attaining a better risk to reward ratio is preferred.
Highly Flexible and Versatile
As we have already mentioned, the versatility factor is the best thing about options contract. There are countless variations and manners in which you can find and a way of creating a source of income.
Risks Involved in Options Trading
Risk is unavoidable trading with option contracts. This has already been laid to the readers at the beginning of the article. Since, risk is the factor of profit or loss, you need to be well aware of what kind of risk you will encounter. This shows the negative aspects of the investment which you may be bound to encounter.
Options trading is just like the stock market investment, and your invested fund is always at risk. The good news is, Options provide a lot of ways and strategies to minimize the risk. This does not necessarily eliminate the risk factor entirely, as you will bear certain direct and indirect risks. Here are the aspects of risk stated, to expand your knowledge.
We have a lot of options available, which lets us creating a new window of income source. There are also strategies to reduce the risk up to an extent; however avoiding risk entirely is not a possibility. Options especially are highly risky, and while you can minimize the risk, there is a fair chance you can encounter losses.
Experience is a contributing factor, as you will learn how to invest while keeping risk at minimum. But this does not eliminate the risk factor entirely, and you can, at times, make losses.
The catch here is, to read the strategy you deploy prior to execution, in order to figure out the extent of losses, if any. This shall help you cope up with unfavourable circumstances.
Strategies by the very name they are referred to, denote complexity. This nature is an add on to the risk factor, an investment posses. Hence, it is very essential that the investor knows the step he has been taking, and the strategy is rightfully implemented. This is because mistakes can actually cost you a lot more than you can expect.
This form of investment is being adopted widely and the user base has expanded. This doesn’t affect the fact that some contracts are indeed less liquid. The reason is that, there are a lot of options trading, and there is a possibility that the option you chose is not provided for trading in bulk.
This may or may not be an issues, as the issues is of trading the securities at right prices, which eventually can be eliminated via fewer volume trading, or trading in the most popular securities.
There is a cost involved in trading options, which is basically linked to bid and ask price. Bid price is the amount received for writing an option, whereas ask price is the amount paid for buying the option. There are also other types of costs associated, including the cost of creating spreads, i.e. commissions.
This is another form of risk you cannot avoid. It simply drafts that the options you have will lose their value in accordance with passing time. This is because time factor is obvious in options, and longer the expiration, higher will be the time value.
You need not go down in value because of the previous explanation, which was just to show you that time decay does impact an option’s value.
Where to Trade in Options?
Well, we have portrayed the entire scenario to our readers, about options. The next step is to learn about the platforms which are used to trade options. This section merely tells you about the platforms which can be used to buy, sell or even write a contract.
Getting started, you cannot do the process all by yourself, and you need to avail for additional services, which give lets you carry on the process of placing trades. Basically, you will need to avail for the services of a stock broker, which will in turn give you access to options trading.
Trading in Options through brokers
It is an obvious factor to invest with a stock broker as we have already explained. Brokers have terms and departments who specialize in this arena of investment and they follow your instructions on investment and make the trade on your behalf. However, a commission charge is implied on each transaction, which generally ranges.
The issue is of selecting the right stock broker. This can indeed be a difficult position you will find yourself in. However, if you invest in stock with a broker, you can avail for options investment too. If you are a beginner, we suggest you do your research and select the broker you feel is correct.
Types of Brokers
There are generally two types of brokers, i.e. full service brokers and full service brokers. Full service brokers are generally referred to as the traditional brokers and provide a large amount of investment solutions, including recommendations and advice facility. They are however expensive for the kind of services they provide.
Traditional brokers provide you a personalized experience altogether, and charge high brokerage or commission. On the other hand discount brokers are cheaper.
To fulfil the modern need of investor, discount brokers come into the market. They offer technology based financial solution, at a much cheaper rate of brokerage and commissions. They operate online entirely, and have no physical presence whatsoever. Here you are majorly by yourself and no guidance is provided.
Hence, if you want a medium to execute your order and are an expert in options investment, you must avail for a discount broker. However, if you have limited knowledge and are a beginner, you must probably avail for full service brokers.
Options Trading: Conclusion
We hope the entire concept of options is now clear to you. We have tried to convey all the basics of options trading, which will play a huge role in getting you started and ready to take on the world of options trading. Options trading is worth a shot, and with the right kind of assistance and knowledge, you can definitely ace it.
Compatible for small terms investment, you can create a new source of income in the short run via options. There is always a first time to everything, and while you enter this market as a beginner, you will quickly gain the required experience and become a pro.
However, if you are puzzled regarding who can invest, and if options trading is only feasible for experts, here is your answer. Options trading is equally profitable for both beginners and experts. There are a lot of options strategies; many of them are to serve the experts, while others are for beginners.
This is the borderline of trading in Options, which is, it is a highly profitable investment alternative for everyone.
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