Basics Of Option Trading

Basics of option trading

Basics of option trading.

Firstly we need to know about where this option trading come from.

It is the part of derivative family.

A derivative is a contract between two or more parties whose value is based on underlying financial asset or set of asset.

There are many derivatives :-

  • Option.
  • Future contracts.
  • Forward contracts.
  • Swaps.
  • Warrants.

Basics Of Option Trading

But today we are talking about basics of option trading.

Options are trading instrument in which a contract is made between two parties.

Stock option buyer purchases the right to sell or buy shares of  an underlying stock at a predetermined price from or to the option seller within a fixed period of time.

Basics Of Option Trading

Options can be traded on several kind of underlying securities.

The most common one are :-

  • Stocks.
  • Indexes.
  • Exchange traded funds.

So feel to substitute your preference style of trading.

If you want to have quick results with limited investments and higher returns, you must go for option trading.

Shares are not of your interest, as it requires patience to get a good amount of return.

Than you must invest in option instrument.

 

Basics Of Option Trading

The buyer of the option gives the premium to seller in the hope or speculation, that the price will go high before the expiration of the agreement.

Option involve certain risks because of reason, it is able to high return.

That is why a disclaimer is always made before the investor before investing into the option instrument.

“Option involve risk and is not suitable for everyone. Option trading is speculative in nature and carry sustainable risk of loss. Only invest with risk capital.”

Thus every single word is to be read necessarily, as in case of loss or profit, you are already known about the facts and figures.

Basics Of Option Trading

Stock as an investment product is to invest in the shares of the company.

And thus it represent part ownership in the company and entitles to its corporation earnings and asset.

Basically stocks are two types :-

  1. Equity shares.
  2. Preference shares.

Whereas option are typically of two types :-

  1. Put option.
  2. Call option.

There are many reason which are mentioned below :-

  • Stocks are defined in number while options are not.
  • Option has fixed expiration period where else stocks has no such expiration dates.
  • Expiration dates varies from weeks, months to years depending upon the regulation and the type of option you are practicing.

Basics Of Option Trading

  • Option derive their value from something else and belong to derivatives where in stock their is no such roles.
  • In option, investor can make a profit even when the price go down and in case of stock, investor cannot make profit if prices go down.
  • Stock owners have voting rights in the company, where their is no such benefit to the option holder.
  • Stock price are mainly on primarily on market forces, whereas option prices are based to a large degree on the price of the underlying asset.

 

Basics Of Option Trading

Option are bought and sold on the strike price.

Strike price is the price at the underlying stock are bought and sold as per the contract.

Since, the option premium does not have its underlying value, so the option premium is the price that the buyer has to pay for purchasing the option.

Basics Of Option Trading

Various factors determining premium :-

  • Underlying stock price.
  • Volatility in the market.
  • And the days until the option expires.

Through underlying asset, price of the option is determined.

So the underlying asset can be –

  1. Stocks.
  2. Futures.
  3. Index.
  4. Commodity.
  5. Currency.

Basics Of Option Trading

Types of option –

Option can be of two types :-

  1. Call option.
  2. Put option.

Call option is an option to buy an underlying stock on or before the expiration date.

At the time of buying call option, the buyer has to give a certain amount to the seller.

So that the seller can grant the right to buy the underlying asset at the strike price.

Basics Of Option Trading

Put option is an option to sell an underlying stock on or before the expiration date.

Investor is bearish about the market and hoping that the price may go down of the underlying stock that is when put option is purchased.

In this case, You want make in put option than the price of the underlying stock should go down from the strike price.

Basics Of Option Trading

Moneyness is one of the important term, you must know about.

It is basically the relationship between the strike price of the option and the current price of the underlying asset.

Basics Of Option Trading

Below are some of the option strategy :-

  1. Covered call.
  2. Married put.
  3. Bull call spread.
  4. Bear put spread.
  5. Protective collar.
  6. Long straddle.
  7. Long strangle.
  8. Iron butterfly.
  9. Iron condor.
  10. Long call butterfly spread.
Basics Of Option Trading

You must know about when is option:

  1. In  the money.
  2. Out the money.
  3. At the money.
  • When is an option in the money?

Call option – When the underlying stock price is higher than the strike price.

Put option – when the underlying stock price is lower than the strike price.

  • When is an option out of the money?

Call option – When the underlying stock price is lower than the strike price.

Put option – When the underlying stock price is higher than the strike price.

  • What is at the money?

When the underlying stock price is equal to strike price.

 

Basics Of Option Trading

These are the basics of option trading, now you can implement it to option trading strategy.

Dispersion trading strategy is one of strategy, you can start to implement.

As it is very easy to start for the option trading lovers.

So if you want to invest in option trading, you should know every determinant of it.

As it contains unlimited loss, and has a certain amount of loss.

But once you understand, how option trading work, one can leverage unlimited profit.

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