Options can be a little confusing for those new to the market. However, with a little bit of
research and education, options can be an incredibly powerful and profitable tool for traders
This option trading guide will cover the basics of options trading, how to get started, and some
tips to help you become successful.
What are Options?
Options are contracts that give the owner the right but not the obligation to buy or sell an asset
at a specific price on or before a certain date. Options are broken down into two categories: call
options and put options.
Call Option
A call option is the right to purchase an asset at a predetermined price (the strike price) within a
certain time frame. If you own a call option on Apple stock with a strike price of $200 and the
stock is trading at $225, you have the right to purchase the stock at $200 even if the market
price rises to $250.
Put Option
A put option is the right to sell an asset at a predetermined price (the strike price) within a
certain time frame. If you own a put option on Apple stock with a strike price of $200 and the
stock is trading at $225, you have the right to sell your shares for $200 even if the market price
drops to $150.
How do Options work?
Options are traded between the person who owns the option (the buyer) and the seller of that
option. The market maker is not involved in most options traders. However, the market maker’s
job is to set an exchange price for each contract traded at a certain time every day.
Option Contracts
An option contract has two components; intrinsic value and extrinsic value. Intrinsic value is the
difference between the underlying stock price and the strike price. Extrinsic value is everything
else. It’s what you pay for the options contract itself.
When trading options, two orders can be placed: a buy order or a sell order. A buy order is an
order to purchase a chance hoping that the stock will rise in value and can be exercised for a
profit. A sell order is an order to sell an option contract with the expectation that the stock will
decline in price and be exercised for a gain.
A “market order” is an immediate order to buy or sell at the current market price. It guarantees
that your trade will be executed but does not guarantee the price you receive for the security
traded.
For more advanced traders, a limit order allows them to set their specific parameters of when
they are willing to buy or sell an option. A limit order can be placed as a market order. However,
it will only execute if the defined parameters are met or exceeded by current market prices.
Why do investors trade options?
There are three main reasons to trade options: income, speculation, and hedging. Investors that
want additional income buy call or put options to hold them until they reach expiration, at which
point, if their stock has risen in value (for a call option), it can be exercised for a profit.
Speculators use trading strategies like spreads and straddle to increase their potential profits.
Meanwhile, hedgers use options to protect their investments from downside risk.
Options can be used in various ways, making them an incredibly versatile investment tool. As
per the SoFi Invest experts, “Sellers of options may be obligated to buy or sell shares however if
the investor on the other side of the trade exercises their contracts.” With a small amount of
education and research, options can provide traders with opportunities for tremendous profits.