Although options are speculative in nature, you can have a large payoff if you play your cards right. At first glance, options trading may seem a bit complicated. When you start to understand key concepts related to it, you can begin to understand how beneficial this type of trading can be. Start getting to know the basics of trading options in this guide.
Options are contracts that give you the right to buy or sell a stock at a determined price and date, without having any real obligation to do so. Similar to ETFs, mutual funds, stocks, and bonds, options are another type of asset class. They fall into a larger group of derivatives, meaning that their price is linked to the price of something else.
They consist of two variants: a call options contract and a pull options contract. The former is when the holder has the right to buy a stock. The latter is when the holder has the right to sell a stock.
Benefits of Using Options
If you correctly anticipate a stock to rise or fall, using options can payout significantly. However, like other underlying assets, they come with a risk. Prior to getting an options contract, make sure you weigh your risks.
When you think the price of a stock is going to fall, you may want to get a pull options contract. This way, you can sell at a higher price than the stock is worth. When you think a stock price will rise, you may want to get a call options contract so you can buy a stock at a lower price than it is worth.
Measuring Options Risks
Traders use the Greeks to measure the risks of an options contract. These measurements are named after Greek letters and include the following:
- Delta: Impact of change of price of an underlying asset.
- Gamma: Delta’s change of rate.
- Theta: Impact of a change in the time remaining.
- Vega: Impact of a change in volatility.
How to Trade Options
Follow these steps to get started on trading options:
- Open your account. Before you can begin to consider which options to buy or sell, you must open an options trading account. When inquiring to work with a broker, they will ask you about your personal financial information to see if you’re a viable investor. Based on your answers, they will assign you to an initial trading level.
- Consider where the stock will go. When it’s time to trade options, you need to anticipate the direction of a stock, how high or low it will go, and the time frame of it all.
- Talk to your broker. The purpose of hiring a broker is so they can provide you with resources, such as research, support, and guidance. This is why prior to opening an account, you should screen multiple brokers.
Now that you have a better understanding of how to trade options, it’s time to look into your first options contract. Remember, options trading comes with a risk, so use the Greeks to determine it before buying or selling.