Options trading seems difficult to many traders but it is easy to understand and generate profits from it. There are a few key points after which you can also earn higher income from the market. It can be done with various assets such as ETFs, Stocks Trading, bonds, and even mutual funds.
Traders who enter any of the options have a right to buy or sell the underlying asset at a specific price. Before the expiration date or on the date, you can trade at any time to earn a profit. These types of trading instruments are known for portfolio diversification and hedging risk.
What Is Options Trading?
Options are also known as derivatives, which means they derive their value from another underlying asset. They do not bound you in an obligation to buy or sell an underlying asset. However, traders who have options have the right to buy or sell a specific underlying asset.
The buyers and sellers of options can execute a contract before the option expires. A strike price is mentioned in the contract along with the date of expiration of the contract. Options are purely based on speculation on the opening and the closing price or an asset.
What is the Strike Price?
The strike price is used in derivative trading. It represents the price at which the contract can be exercised. Both types of options have different strike prices. They provide different rights to their holders.
For example, a call option holder has the right to buy the asset at the strike price. On the other hand, a put option holder has the right to sell at the strike price of the contract.
Types of Options
There are two types of options that are known as call option and put option. Both of them are used in a different manner and they provide their holder with a different right.
Call Option
A call option is the one that offers the right to buy to the option holder. There is no obligation to buy the asset, you are free to calculate your profit and then sell your option in the market. A holder of a call option can buy if the market price rises of the asset to ensure profit.
Put Option
A put option is the one that offers the right to sell to the option holder. However, there is no obligation to sell the asset, only sell if you are making sufficient profit with it. A put holder can sell the asset if the price of the underlying asset falls, he has the option to sell at a higher strike price.
What Are Stock Options?
A stock option is an option contract for an individual stock. Options trading can be done with any trading asset for which it is available. Sometimes due to a breach of guidelines, authorities ban stock from options trading for a few days or weeks.
How to React to a Change In Stock Price?
If you are buying a call option from the market you should wait for the price to increase. When the price increases, it is the right time for selling a call option for the holder within the expiration date. On the other hand, if you buy a put option, and put option gives you the right to sell.
Traders want to sell at higher prices than the market prices. Therefore, when there is a fall in the market price, it is the right time because you still have the right to sell your option at the strike price. Hence, sell shares when the price falls in the market and earn higher profits.
Important Terminologies in Options Trading
There are a few of the important terminologies that you need to understand before you enter into an options contract. The terminologies are:
- Premium – It refers to that price, an option buyer pay to the options seller. It is known as premium on options.
- Expiration Date – Expiry date can also be said as exercise date, on this date or before this date traders can exercise their contract.
- Strike Price – There are two types of price, one is the strike price, at which the contract is entered. Another is the exercise price at which a contract can be exercised.
- American Option – These are flexible types of options that can be exercised anytime before or on the date of expiration.
- European Option – These types of options are rigid and they can only be exercised on the date of expiration and not before that.
Profitability Scenario in Options
The profitability is noted in various ways in options trading. The ways are discussed below, traders should understand all are the situations from which they can earn profits:
In-the-Money Option
In-the-money (ITM) option, is the situation of positive cash flow to the holder of options. Therefore, when the spot price is greater than the strike price, it is known as in-the-money.
At-the-Money Option
At-the-money (ATM) options are the situation where there is neither positive nor negative cash flow. The spot price is equal to the strike price in this situation.
Out-of-the-Money Option
Out-of-money (OTM) option is a situation when the holder of options is in negative cash flow. Therefore, during this, the spot price is lesser than the strike price.
The Best Options Trading Strategies
To bring success and profits with options trades you will need a few of the best options strategies. These strategies are proven and they can be used to earn higher income with options trading. The strategies are:
Covered Call
Traders make a mistake, which is they buy a call and do not buy cover. Instead of buying a call for trading, you should call with another for a higher probability of profits. In this way, you can also reduce your risk of trading in the market.
Traders can buy stocks as normally they buy and for cover they can sell a call option on the same set of shares. In this scenario, your short call is covering the long position of the stocks. Therefore, you can reduce risk and earn higher profits.
Bull Call Spread
In this options strategy, traders buy call options at specific prices and at the same time they sell the same number of call options at a higher strike price. The asset and expiration date is the same with both the call options.
This strategy allows traders to limit their upside and the ability to reduce their net premium in the market. Bullish investors see this type of vertical spread options trading strategy to earn higher income from their trades.
Protective Collar
In this trading strategy, out-of-money put options are purchased along with writing an out-of-the-money call option. Traders use this type of strategy in long positions. Traders secure themselves from the downside of an asset but buying a put option and securing their sale price.
In the long run, this type of options trading strategies can be very profitable. Therefore, secure your long position by buying a put option at the same time.
Married Put
This trading strategy is used to secure the stocks or assets bought by purchasing a put option at the same time. An equivalent amount of assets are purchased in the put option. It is done to secure the asset from sudden downfall.
Investors choose this trading strategy to protect their trading assets from a downfall. They can get returns from the put option if the market falls. Therefore, this is done to ensure earnings from your trades.
Long Straddle
This is an options trading strategy that focuses on purchasing of call and put options at the same time. The strike price, underlying asset and the expiration date of the contract are the same for both options.
This is done when an investor is confused about which direction the price of the asset will move. Therefore, by this traders can reduce their loss and earn higher profits from the market.
Advantages of Options Trading
Traders should use the best options strategies to fetch the advantages of trading with them. The benefits of trading options are listed below:
- Margins or leverage are available for trading options which is the best advantage
- Traders need to invest less capital if they are trading with the use of leverage
- High returns are possible and due to this they are good for wealth management
- Even with lower investment and the use of margins your returns do not get affected
- Options contracts provide hedging and risk are reduced with the help of hedging
- Traders just need to pay option premium and the rest is their profits
- Long positions and short-selling both are available with option trading
Disadvantages of Options Trading
There are a few of the disadvantages also of trading options, which are as follows:
- Options trade provide lesser liquidity to a trader
- There is a high commission of trading options
- The option is not available with every stock and trading asset
Brokers for Trading Options
There are a huge number of online brokers but traders should choose the one which is offering the maximum trading benefits and features. Compare different brokers and after an in-depth comparison between brokers select the best one. A few of the leading broker is as follows:
Capixal
- Authorised and regulated by the Cyprus Securities and Commission Exchange (CySEC)
- 350+ trading instruments are available with this broker from which a trader can trade
- Traders can trade on MetaTrader 4, WebTrader, and Mobile App trading platforms
- The broker offers a demo account along with silver, gold, and platinum live accounts
- The maximum leverage offered by the broker is 1:500 for day to day trading
- 24/5 multilingual dedicated customer support is available for each trader
- Commission-free trading along with tight spreads and swap charges
- A wide range of analytical tools and educational material freely accessible
- Start Your Trading with Capixal
ETFinance
- Authorised and regulated by the Cyprus Securities and Commission Exchange (CySEC)
- 250+ trading instruments are available with this broker from which a trader can trade
- Traders can trade on MetaTrader 4, WebTrader, and Mobile App trading platforms
- The broker offers a demo account along with silver, gold, and platinum live accounts
- The maximum leverage offered by the broker is 1:500 for day to day trading
- 24/5 multilingual dedicated customer support is available for each trader
- Commission-free trading along with tight spreads and swap charges
- A wide range of analytical tools and educational material freely accessible
- Start Your Trading with ETFinance
101investing
- Authorised and regulated by the Cyprus Securities and Commission Exchange (CySEC)
- 250+ trading instruments are available with this broker from which a trader can trade
- Traders can trade on MetaTrader 4, WebTrader, and Mobile App trading platforms
- The broker offers a demo account along with silver, gold, and platinum live accounts
- The maximum leverage offered by the broker is 1:500 for day to day trading
- 24/5 multilingual dedicated customer support is available for each trader
- Commission-free trading along with tight spreads and swap charges
- A wide range of analytical tools and educational material freely accessible
- Start Your Trading with 101investing
The Bottom Line
Options trading can be highly profitable if used correctly. It can reduce your trading risk and secure your capital. Traders should choose the best strategies for trading along with the best brokers. Study the market and also the benefits and drawbacks of trading options. After getting proper knowledge, start options trading and earn higher returns on your investments.
