There has never been a better time to be a security investor. With multiple asset classes, including stocks, bonds, and ETFs, you have plenty of options to choose from and make some serious profits. Many people go the traditional route when it comes to investing their money. If you’re new, you can check the best stocks for beginners to grow your money! But options trading has many advantages. Options trading has been growing in popularity in recent years, but there are still people who aren’t fully versed in the setup.
To help you understand everything you need to know, here is our guide to options trading and how it works.
What is options trading?
The term “option” refers to an agreement between the investor and the brokerage about permission to buy or trade securities at a predetermined rate on or before a specific date. Common securities to buy options include stocks, bonds, and cryptocurrencies. However, this method of trading is derivative because the investor does not have the obligation to exercise the contract at the pre-decided point.
Purchasing and selling options takes place on the options market, where contracts are traded on a security basis. Options are categorised depending on whether your intention is to buy or sell shares in the future. The former is called “call options”, while the latter is called “put options”.
Since you can always withdraw your contract, options trading is considered to be less risky than other traditional methods, especially if you know about closing a trade at the right time. However, keep in mind that owning options does equate to having ownership in companies. To get the desired option, you will have to pay a portion of the underlying asset, instrument, or security as a premium.
The benefits of options trading
There are various advantages that options trading has over other investment methods. Some of the most beneficial to the investor are:
- Less upfront expense than stock trading: The upfront premium (with additional trading fee) that you have to pay for acquiring an option is significantly less than the purchasing price of outright shares.
- Stable prices for certain periods of time: Option contracts give the investor fixed prices for stocks for a certain period of time. As long as you are willing to trade before the agreement expires, the trading rates will remain the same.
- Better investment portfolio: With options trading comes additional income, leverage, and even protection. When the stock market is showing signs of declining, you can use options trading to minimise losses and turn it into a periodical source of income.
- Various methods and strategies to choose from: Flexible option contracts allow you to employ different strategies to reach your trading goals. You can use options to purchase or sell shares for a profit and create a better investment portfolio. You also have the choice of selling your contracts to other investors at higher rates before the expiration date.
Getting started with options trading
Here are the steps that you have to take to begin your trading journey:
Step 1: Choose a broker
This is the first step that enables you to introduce yourself to the brokerage as a potential investor so that they allow you to use the platform for trading. You will have to provide basic information about your trading goals, experience, financial status, and desired trade options. Make sure to compare different brokerages in terms of features, prices, and support, so that you can pick out the one that best suits your needs.
Step 2: Choose your options
Having a better understanding of ‘call’ and ‘put’ options will help you get suitable contracts for different circumstances. Your expectation of how the underlying securities will change over time will also play a factor in ensuring that you employ the right trading strategies.
Step 3: Predict the strike price
For options trading, it is best to buy those with strike prices that are close to your estimated number. Of course, you cannot just randomly come up with a number. Options quotes will recommend various strike prices for you to look at and assess.
Step 4: Estimate the time frame
In short, contracts with longer expiration periods (measured in months or years) are better at allowing your investment theory to play out. However, you might not want to pay the expensive premiums for such contracts, so consider your needs and options carefully before making the decision. If the trade is working well, cashing in before the expiration date makes perfect sense. However, if things are not playing out the way you want them to, you can close the trade and move on.
Options trading is not difficult, especially when you have grasped the fundamentals. Getting started is super easy, and as long as you are willing to educate yourself and improve your trading skills, you will be well set for success. With the right approach, making a profit and building an excellent investment profile is achievable for everyone.
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