Key TAKEAWAYS
UNDERSTANDING OPTION TRADING
Options trading can be compared with betting on the horses at the racetrack. So, the chances of either winning all the profit or losing it all are one of the key features of futures trading.
Moreover, owing a stock means that a trader is entitled to the direct ownership of the stock but options only give a trader the right to buy or sell the contract based on stocks on a specified date at a pre-determined price.
What are Options?
Options are financial security derivatives. They are contracts based on underlying financial security and their value depends on the price movement of underlying assets, say stocks.
Options trading provides the trader with the right but not the obligation to sell or buy the underlying security at the predetermined price before the expiration date of the contract.
TYPES OF OPTIONS
There are two types of options:
Calls: Buying a call option provides a trade the right and not the obligation to buy the underlying stock at a predetermined price before the expiration of the contract. The set price at which the call option is executed is called the strike price.
Puts: Buying a put option provides a trader the right and not the obligation to sell the underlying stock at the strike price before the expiration date of the contract.
How are the options created?
Options are created by traders who are owners of the stocks. This is also known as ‘writing an option’ and it is the main source of option creation since the time of the inception of this concept.
Options Pricing & Profitability
The initial price, also termed as premium, is the amount that a trader has paid for the option and doesn’t afford to lose it. Therefore, the risk involved in options trading is for the premium that a trader has paid. On the other hand, the profit potential of the option remains unlimited theoretically.
In exchange for the premium for the stock, a seller is bound to have a risk on Call or Put option due to the fluctuation in the strike price, if it doesn’t get favorable. To save the open-ended loss, sellers cover the option with another option.
If the strike price of a call option is more than the current stock price, such a call is not a profit instead the call can be called as out-of-money as other investors are not going to buy the underlying stock at the elevated price when they can buy it at lower current market price.
Conversely, when the price of the underlying stock in options trading is less than the current market price, buying such an option is a profitable deal and also known as in-the-money because investors are going to buy the stocks at a lower price than the current market price.
However, the working of a put option is exactly the opposite. Put options are considered as out of the money in case the strike price is lower than the stock price as an investor isn’t going to sell at a price lower than the market price whereas a Put option is considered in-the-money when the price of stocks is lower than the strike price as the seller, are willing to sell the stock at an elevated price.
Do Options Expire?
All Options covering stocks expire at certain expiration date. Generally, options that are normally listed expire after nine months from the first listing date whereas Long term Options can have an expiration date of up to three years.
Option expiration is strongly linked with the market close and market holidays. Generally, all market options expire on Friday. In those cases where the date of expiration coincides with a market holiday, the expiration of the contract shifts a day back.
Options are meant to be settled the other day of contract expiration, unlike stocks where a two days period is available for the settlement. To settle the trade on the expiration date, an option is required to be traded at the end of the expiration day.
Styles of options:
An American style option can be transacted at any date between the purchase date and the date of expiration whereas a European style option can be transacted only at the date of expiration. Majorly, all the stock options are created in American style and many Index options are created in European style. Most of the options that are traded in the market are American style options.
CONCLUSION
Options Trading is a lucrative investment choice due to its versatility and lower investment than stocks. It allows traders with different strategies to work with it to achieve their financial gains. Similar to other trading instruments, options have their advantages and drawbacks that are required to be addressed by a day trader before opting for a suitable strategy to execute Option trading.
Day trading is indeed a lucrative career but also a challenging one. Before a trader enters in the market, they should be equipped with the knowledge of the trading world and possess risk tolerance ability along with a good amount of capital and a clear goal.
A day trader is someone who capitalizes by carrying out long and short volume trades on the fluctuations in the market price action.
Day trading refers to a practice of buying and selling a security within a day. This can be seen at various marketplaces but it can be most often seen at stock markets and foreign exchange (forex).
