Trading options definition

Options are a type of derivative product that allow investors to speculate on, or hedge against, the volatility of an underlying stock. Options are divided into call.
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If you're buying a call option, it means you want the stock or other security to go up in price so that you can make a profit off of your contract by exercising your right to buy those stocks and usually immediately sell them to cash in on the profit. The fee you are paying to buy the call option is called the premium it's essentially the cost of buying the contract which will allow you to eventually buy the stock or security.

In this sense, the premium of the call option is sort of like a down-payment like you would place on a house or car.

Types of options

When purchasing a call option, you agree with the seller on a strike price and are given the option to buy the security at a predetermined price which doesn't change until the contract expires. So, call options are also much like insurance - you are paying for a contract that expires at a set time but allows you to purchase a security like a stock at a predetermined price which won't go up even if the price of the stock on the market does.

However, you will have to renew your option typically on a weekly, monthly or quarterly basis. For this reason, options are always experiencing what's called time decay - meaning their value decays over time. For call options, the lower the strike price, the more intrinsic value the call option has. Conversely, a put option is a contract that gives the investor the right to sell a certain amount of shares again, typically per contract of a certain security or commodity at a specified price over a certain amount of time. Just like call options, a put option allows the trader the right but not obligation to sell a security by the contract's expiration date.

Just like call options, the price at which you agree to sell the stock is called the strike price, and the premium is the fee you are paying for the put option. Put options operate in a similar fashion to calls, except you want the security to drop in price if you are buying a put option in order to make a profit or sell the put option if you think the price will go up. On the contrary to call options, with put options, the higher the strike price, the more intrinsic value the put option has.

Unlike other securities like futures contracts, options trading is typically a "long" - meaning you are buying the option with the hopes of the price going up in which case you would buy a call option. However, even if you buy a put option right to sell the security , you are still buying a long option. Shorting an option is selling that option, but the profits of the sale are limited to the premium of the option - and, the risk is unlimited. For both call and put options, the more time left on the contract, the higher the premiums are going to be.

What Is Options Trading? Examples and Strategies - TheStreet

Well, you've guessed it -- options trading is simply trading options and is typically done with securities on the stock or bond market as well as ETFs and the like. When buying a call option, the strike price of an option for a stock, for example, will be determined based on the current price of that stock. However, for put options right to sell , the opposite is true - with strike prices below the current share price being considered "out of the money" and vice versa.

And, what's more important - any "out of the money" options whether call or put options are worthless at expiration so you really want to have an "in the money" option when trading on the stock market. Another way to think of it is that call options are generally bullish, while put options are generally bearish. Options typically expire on Fridays with different time frames for example, monthly, bi-monthly, quarterly, etc.

Many options contracts are six months. Purchasing a call option is essentially betting that the price of the share of security like stock or index will go up over the course of a predetermined amount of time. When purchasing put options, you are expecting the price of the underlying security to go down over time so, you're bearish on the stock. This would equal a nice "cha-ching" for you as an investor. Options trading especially in the stock market is affected primarily by the price of the underlying security, time until the expiration of the option and the volatility of the underlying security.

The premium of the option its price is determined by intrinsic value plus its time value extrinsic value. Just as you would imagine, high volatility with securities like stocks means higher risk - and conversely, low volatility means lower risk. When trading options on the stock market, stocks with high volatility ones whose share prices fluctuate a lot are more expensive than those with low volatility although due to the erratic nature of the stock market, even low volatility stocks can become high volatility ones eventually.

Historical volatility is a good measure of volatility since it measures how much a stock fluctuated day-to-day over a one-year period of time. On the other hand, implied volatility is an estimation of the volatility of a stock or security in the future based on the market over the time of the option contract.

Essential Options Trading Guide

If you are buying an option that is already "in the money" meaning the option will immediately be in profit , its premium will have an extra cost because you can sell it immediately for a profit. On the other hand, if you have an option that is "at the money," the option is equal to the current stock price. And, as you may have guessed, an option that is "out of the money" is one that won't have additional value because it is currently not in profit.

For call options, "in the money" contracts will be those whose underlying asset's price stock, ETF, etc. For put options, the contract will be "in the money" if the strike price is below the current price of the underlying asset stock, ETF, etc. The time value, which is also called the extrinsic value, is the value of the option above the intrinsic value or, above the "in the money" area.

If an option whether a put or call option is going to be "out of the money" by its expiration date, you can sell options in order to collect a time premium. The longer an option has before its expiration date, the more time it has to actually make a profit, so its premium price is going to be higher because its time value is higher. Conversely, the less time an options contract has before it expires, the less its time value will be the less additional time value will be added to the premium. So, in other words, if an option has a lot of time before it expires, the more additional time value will be added to the premium price - and the less time it has before expiration, the less time value will be added to the premium.

According to Nasdaq's options trading tips , options are often more resilient to changes and downturns in market prices, can help increase income on current and future investments, can often get you better deals on a variety of equities and, perhaps most importantly, can help you capitalize on that equity rising or dropping over time without having to invest in it directly. There are a variety of ways to interpret risks associated with options trading, but these risks primarily revolve around the levels of volatility or uncertainty of the market.

For example, expensive options are those whose uncertainty is high - meaning the market is volatile for that particular asset, and it is riskier to trade it. There are numerous strategies you can employ when options trading - all of which vary on risk, reward and other factors.

Call and Put Options Defined

And while there are dozens of strategies most of them fairly complicated , here are a few main strategies that have been recommended for beginners. With straddles long in this example , you as a trader are expecting the asset like a stock to be highly volatile, but don't know the direction in which it will go up or down.

When using a straddle strategy, you as the trader are buying a call and put option at the same strike price, underlying price and expiry date. This strategy is often used when a trader is expecting the stock of a particular company to plummet or skyrocket, usually following an event like an earnings report.

For example, when a company like Apple AAPL - Get Report is getting ready to release their third-quarter earnings on July 31st, an options trader could use a straddle strategy to buy a call option to expire on that date at the current Apple stock price, and also buy a put option to expire on the same day for the same price.

For strangles long in this example , an investor will buy an "out of the money" call and an "out of the money" put simultaneously for the same expiry date for the same underlying asset. Investors who use this strategy are assuming the underlying asset like a stock will have a dramatic price movement but don't know in which direction. What makes a long strangle a somewhat safe trade is that the investor only needs the stock to move greater than the total premium paid, but it doesn't matter in which direction.

The upside of a strangle strategy is that there is less risk of loss since the premiums are less expensive due to how the options are "out of the money" - meaning they're cheaper to buy. If you have long asset investments like stocks for example , a covered call is a great option for you. This strategy is typically good for investors who are only neutral or slightly bullish on a stock.

A covered call works by buying shares of regular stock and selling one call option per shares of that stock. This kind of strategy can help reduce the risk of your current stock investments but also provides you an opportunity to make a profit with the option.

Covered calls can make you money when the stock price increases or stays pretty constant over the time of the option contract. However, you could lose money with this kind of trade if the stock price falls too much but can actually still make money if it only falls a little bit. But by using this strategy, you are actually protecting your investment from decreases in share price while giving yourself the opportunity to make money while the stock price is flat. With this strategy, the trader's risk can either be conservative or risky depending on their preference which is a definite plus. For iron condors , the position of the trade is non-directional, which means the asset like a stock can either go up or down - so, there is profit potential for a fairly wide range.

Buyers of European-style options may exercise the option— to buy the underlying—only on the expiration date. Options expirations vary and can be short-term or long-term. With call options, the strike price represents the predetermined price at which a call buyer can buy the underlying asset. The call buyer has the right to buy a stock at the strike price for a set amount of time. For that right, the call buyer pays a premium. If the price of the underlying moves above the strike price, the option will be worth money it will have intrinsic value.

The buyer can sell the option for a profit this is what many call buyers do or exercise the option receive the shares from the person who wrote the option. Writing call options is a way to generate income.


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However, the income from writing a call option is limited to the premium, while a call buyer has theoretically unlimited profit potential. One stock call option contract actually represents shares of the underlying stock. Stock call prices are typically quoted per share.

Therefore, to calculate how much it will cost you to buy a contract, take the price of the option and multiply it by Call options can be in, at, or out of the money :. You can buy a call in any of those three phases. However, you will pay a larger premium for an option that is in the money because it already has intrinsic value.

Option (finance)

Put options are the opposite of call options. Here, the strike price is the predetermined price at which a put buyer can sell the underlying asset. The put buyer has the right to sell a stock at the strike price for a set amount of time. For that right, the put buyer pays a premium. If the price of the underlying moves below the strike price, the option will be worth money it will have intrinsic value. The buyer can sell the option for a profit this is what many put buyers do or exercise the option sell the shares.

The put seller, or writer, receives the premium. Writing put options is a way to generate income. However, the income from writing a put option is limited to the premium, while a put buyer can continue to maximize profit until the stock goes to zero. Put contracts represent shares of the underlying stock, just like call option contracts. To find the price of the contract, multiply the underlying's share price by Put options can be in, at, or out of the money, just like call options:.

Just as with a call option, you can buy a put option in any of those three phases, and buyers will pay a larger premium when the option is in the money because it already has intrinsic value. Securities and Exchange Commission.