Options trading is a contract that deals with an underlying asset and hence, 'options' are called derivatives. The trade derives value from some other external factor. The underlying asset, which is mostly a stock or index, is influenced by the market values that are very volatile in the face of competition and demand. Let's understand some essential terms:
✦ There are two types of options; they are termed as 'calls' and 'puts'. While a 'call' provides the investor the right to buy an asset within a specific period of time, and at a certain value, a 'put' provides the investor the right to sell an asset under similar conditions.
Calls enable possession of stock for a longer time, with the hope that the stock value will increase substantially before the option expires. A 'put' offers possession of a stock for a shorter time.
✦ It is important to know the four types of participants in this market. Their roles largely depend on the position they take. They are namely 'buyers of calls', 'sellers of calls', 'buyers of puts', and 'sellers of puts'. Investors who buy options are referred to as the 'holders', while those who sell them are the 'writers'.
✦ 'Call' and 'put' holders have a choice to either buy or sell, according to their rights. On the other hand, 'call' and 'put' writers are obligated to buy or sell. Selling options are considered more complicated and even riskier.
✦ It is important to know the terminology associated with this market. There are a number of online and offline resources that help you understand these terms in detail and even help you in application.
1. The strike price, or one at which an underlying stock can be purchased or sold, should go 'above' in the case of calls and 'below' for puts, before the expiration date, for a position to be profitable and generate a positive return on investment.
2. Learn and observe the national options exchange or listed options on dedicated stock exchanges such as the CBOE. The fixed strike prices and expiration dates that represent 100 shares of company stock helps calculate its efficiency and subsequent profit.
3. The option is 'in the money' if the share price is above strike price in the case of a 'call'. In a put option, the same is reversed. It is important to capitalize on the intrinsic value or difference.
4. The total cost or premium of this instrument is determined by research on stock price, strike price, time value, and volatility of the market. This is complicated and should be done step by step with a thorough understanding of the market.
5. Make the most of video tutorials that are easily accessible for online trading. They help you to develop a hands-on approach towards utilization of trading resources and compounding your gains.
Buying an option is not like other leveraged products. You cannot lose more than what is in your account. However, the investments decay in price over time and hence, it is good to keep a regular watch on them and identify the right time to exercise your option.
Disclaimer: This information is for reference purposes only and does not directly recommend any specific investment choices.